• Associations & Nonprofit Corporations Law
  • Forming an Unincorporated Association
    • Unincorporated Association Law
    • Articles of Association
  • Becoming a Tax-Exempt, Not-For-Profit Corporation
    • Benefits of Tax-Exempt, Not-For-Profit Status
    • Drawbacks of Tax-Exempt, Nonprofit Status
    • Nonprofit Corporations in Texas
      • Necessary Documents
      • Officers and Directors
  • Getting Tax-Exempt Status for a Nonprofit
    • Nonprofits that Qualify for Federal 501(c)(3) Status
      • Charitable Purpose
      • Religious Group
      • Scientific Organization
      • Educational Organization
      • Literary Purpose
    • Application for Federal Tax-Exemption
    • Qualifying for State Tax-Exempt Status
  • Resources

Most people recognize the value of associating with others who have similar interests, concerns, occupations, or professions. Historically, people have formed associations in order to share interests or further common goals. Associations have ancient roots: during medieval times, and even earlier, merchants formed trade guilds. Today, associations and nonprofit corporations continue to proliferate in occupations and professions, as well as in many other areas of people's lives. Associations and nonprofit corporations provide members with opportunities for education, information exchange, social activities, research sources, and political power. Not only do businesspersons benefit from membership in such groups, but their organizations also may become members of associations made up of businesses, commonly known as federations. Some businesspersons may find themselves organizing or directing associations or nonprofit corporations. For these reasons, it is helpful for business leaders to understand the structural options available to nonprofit groups. An organization will need professional advice from an attorney to establish the business, and from an accountant to oversee financial matters once the association is in operation. This chapter describes the benefits of cooperative, unincorporated associations, as well as the benefits connected to not-for-profit corporation status, and explores formation, organization, and tax issues.

While many nonprofit associations benefit from forming not-for-profit corporations, small, local, or labor organizations tend to prefer an unincorporated association format. Local musical, religious, or literary clubs, for example, may not have the financial or human resources to obtain and maintain nonprofit status. Not-for-profit corporation status, discussed below, tends to be advantageous to larger groups with activities and relationships external to the organization. Small charitable organizations, such as family trusts, do not seek public funds or otherwise deal outside of the association. These organizations would not benefit from nonprofit corporation status, and incorporation would add additional and unnecessary legal requirements and possible liability.

Unincorporated Association Law

Just because an association takes a less formal approach to its formation, however, does not mean that it should grow haphazardly. Members of unincorporated associations should be aware that without some formal planning, associations risk running afoul of the law. Early organization becomes particularly useful once an association starts to grow in membership and resources. Most states do not have laws that govern unincorporated associations in general, although they may have statutes concerning specific types of associations. Texas, for example, has adopted the Uniform Unincorporated Nonprofit Association Act. The laws generally do not mandate registration or internal procedural requirements for associations, unless they become not-for-profit corporations. Instead, the laws primarily address liability and property ownership issues. An attorney familiar with associations law can identify and further explain any requirements. Labor organizations (unions) must follow strict federal laws governing their formation, their activities, and their relationships with management and employees. Labor unions are discussed in more detail in the Labor Law Chapter.

Even if there are no statutes dealing with unincorporated associations, some legal principles may be applicable to such groups. Associations may not be formed for illegal purposes. Gun clubs, for instance, are lawful as long as members comply with state and federal gun laws; anti-government groups may be prohibited by laws that outlaw treason, as well as laws that limit the types and amounts of firearms people collect. Historically, an unincorporated association was not liable for the actions of its members because it was not a legal entity subject to suit. However, the trend in the law is to allow even unincorporated associations to sue and be sued. Texas generally allows such actions. Furthermore, in some states, individual association members may be liable for acts of other members under the traditional law of agency. For instance, a member of a musical society who contracts for a group performance may, even unintentionally, hold the other members responsible for upholding the contract. In effect, members of associations may act as agents for other association members. Some state statutes, such as the Texas Uniform Unincorporated Nonprofit Association Act, however, specifically limit the liability of members. A manager of an association also may have a fiduciary duty, that is, the association has placed the person in a position of trust and confidence. He or she is required to act in good faith and in the best interests of the association. Similarly, the law of estate planning and probate, tort law, property law, criminal law, or even state anti-discrimination law, may apply to an unincorporated association.

Articles of Association

Every association should have articles of association. Sometimes referred to as the charter or the constitution, the articles of association contain a statement of the association's purpose and an outline of the procedures it will follow. Some states require an unincorporated association to file its articles of association with the secretary of state, the county clerk, or another state or local agency. The charter should be tailored to the particular organization, but most articles of association contain the following:

• Organizational purpose

• Organizational structure

• Qualifications for membership

• Methods for appointing leaders

• Internal procedural guidelines, such as frequency of meetings and authority for handling finances

• Tax status

Forming a tax-exempt, nonprofit corporation is a fairly complex endeavor that requires time, money, and an understanding of legal and tax technicalities--all of which may be scarce in organizations that would most likely benefit from tax-exempt treatment and not-for-profit status. Still, the benefits available to nonprofits are so great that it often is worth the time and energy to become familiar with the necessary steps.

Some of the rules governing how a not-for-profit corporation must be formed and operated are complex. The process of becoming a tax-exempt, not-for-profit corporation actually has two distinct phases: (1) creating the not-for-profit corporation, and (2) applying for tax-exempt status for the corporation once it has been created. The chronology of these two phases is important. The second phase--applying for tax-exempt status--will be far simpler for organizations that keep that goal in mind during the first phase.

Benefits of Tax-Exempt, Not-For-Profit Status

The primary benefits of tax-exempt, not-for-profit status are financial. All or most of the money made by a tax-exempt, not-for- profit corporation is free from federal, state, and local taxation, so the organization can devote a larger share of its funds to the purpose for which it was formed. Furthermore, not-for-profit status is often a prerequisite to obtaining private grants or government funding. Donors are more likely to contribute financially to tax-exempt, not-for-profit corporations than to non-exempt organizations because donors can write off the donations on their tax returns. In addition to tax benefits, there may be low-cost postage and advertising rates available to not-for-profit organizations, and many retail stores offer reduced rates to nonprofits and their employees. As with all other businesses, nonprofits are open to lawsuits and liability for the way they conduct themselves. Organizing as a not-for-profit corporation can shield the individuals who run the organization from personal liability for organizational debts.

The often-overlooked advantages of forming a tax-exempt, not-for-profit organization are the internal benefits that the organization gains when required to commit to writing its management structure and corporate purpose. Many nonprofits start out as a small group of committed persons working toward a definite goal. Having to think through the organization's purposes and management procedures can bring clarity, focus, commitment, and structure at an early stage in the organization's life. These qualities can be invaluable as the organization grows, takes on new projects, and adds new members, or if internal disputes arise.

Drawbacks of Tax-Exempt, Nonprofit Status

Just because an organization qualifies for tax-exempt, not-for-profit status does not mean that seeking not-for-profit status is the best plan. Tax-exempt, not-for-profit status does have drawbacks:

• Profits of the organization cannot be divided among workers or directors (although workers and directors may be paid reasonable salaries)

• Only a small amount of the group's income can be earned from sources unrelated to the organization's reason for receiving tax-exempt status

• The assets of the group cannot go toward purposes other than those that warranted the tax-exempt status

Nonprofit Corporations in Texas

Most nonprofit corporations in Texas are governed by the Nonprofit Corporation Act, with administrative authority granted to the Secretary of State. Under the Act, a nonprofit corporation may be formed for any of the following purposes, among others:

• Aesthetic

• Athletic

• Charitable, benevolent, or religious

• Civic

• Educational

• Eleemosynary

• Horticultural, agricultural or animal husbandry

• Missionary

• Patriotic

• Professional, commercial, industrial or trade association

• Scientific

• Social

Necessary Documents

At the very beginning of the process of forming a nonprofit corporation, a group should file articles of incorporation with the Secretary of State's Office. They form the charter document of the corporation. Articles of incorporation must include:

• The name of the corporation

• A statement that the corporation is a nonprofit corporation

• The period of duration, which may be perpetual

• The purpose or purposes for which the corporation is organized

• If the corporation is to have members, and if the members will manage the corporation, a statement to that effect

• The name and address of the corporation's initial office and registered agent

• The number, names and addresses of the initial board of directors

• The name and address of each incorporator

• A statement of the method of distribution of assets upon dissolution, if other than as provided by statute

The nonprofit corporation must hold a meeting of the board of directors. At the first such meeting, the board (unless the members manage the corporation) must adopt bylaws, which define the rules and procedures under which the corporation will operate. The bylaws may not be inconsistent with the articles of incorporation. Bylaws typically include:

• The number, qualifications, manner of election, powers, duties, and compensation of directors

• The qualifications for membership

• Different classifications for members

• The manner of admission, withdrawal, suspension, and expulsion of members

• Property, voting, and other rights and privileges of members

• Appointment and authority of committees

• Appointment or election, duties, compensation, and tenure of officers

• Time, place, and manner of calling, conducting, and giving notice of member, board, and committee meetings or of conducting mail ballots

• Making of reports and financial statements to members

• The numbers required to establish a quorum for meetings of members, committees and the board

Officers and Directors

Every corporation governed by the Nonprofit Corporation Act must state the number of directors in its articles of incorporation and bylaws. The bylaws also may describe the titles and duties of the officers. If the bylaws allow it, the same person may perform the functions of more than one office.

Incorporating means that a business is considered a legal entity separate from its employees and directors; thus, it is able to make contracts and incur liability in its own right. But the employees and directors may be legally responsible for actions taken on behalf of the corporation.

Texas statutes require that the director of a nonprofit corporation discharge his or her duties in good faith, in a manner he or she reasonably believes to be in the best interest of the corporation, and with ordinary care. A director who performed his or her duties in accordance with this standard is not liable simply by reason of his or her position as a director. Directors and officers who serve without compensation generally are not liable for acts of the corporation unless the acts are intentional.

A fairly wide variety of businesses and groups qualify for federal tax exemption. Some groups, such as chambers of commerce, social clubs, and credit unions, may be entitled to federal tax-exempt status under very narrowly drawn statutes not discussed here. A common form of tax-exempt status is found in section 501(c)(3) of the Internal Revenue Code. This is the most desirable form of tax-exemption not only because 501(c)(3) corporations are exempt from federal, state, and local taxes, but also because donors to the organization can qualify for tax write-offs for their contributions. Failure to qualify for tax-exempt status subjects an organization to federal taxation. An association may be subject to taxation as a corporation if it meets three of the four following factors:

• Central management

• Continuity beyond the lives of individual members

• Limited liability of shareholders

• Freely alienable shares

Nonprofits that Qualify for Federal 501(c)(3) Status

There are five different purposes for which the IRS allows organizations to file for tax-exempt status as nonprofit corporations under section 501(c)(3) of the tax code.

Charitable Purpose

The term "charitable" in section 501(c)(3) has a broader definition than in common usage. It refers to anything that has benefit for the public. Organizations established for a charitable purpose may intend to benefit only a relatively small group of people, but may not be so small that the actual beneficiaries are specifically listed. Examples of charitable purposes include the maintenance of public buildings and relief for the poor.

Religious Group

This term also is broadly interpreted. "Religious groups" include mainstream organizations such as churches and temples, as well as many other organizations of people with truly and sincerely held beliefs. The only necessary factor for qualifying as a religious group is that the group be pursuing the advancement of religion. It is more difficult to qualify as a "church" for tax-exempt purposes than it is to qualify as a religious group.

Scientific Organization

A group with the primary purpose of scientific research in the public interest is eligible for tax-exempt status. Research is considered to be in the public interest if the results eventually are made available to the public.

Educational Organization

"Educational organization" is another broadly defined filing category in which endeavors aimed at self-development as well as community benefit are allowed tax-free status for the purpose of education. A person or group may qualify under this purpose to espouse a point of view, provided it is not a political position. Parent-teacher organizations associated with schools generally fall into this category.

Literary Purpose

"Literary purpose" is a rarely used category for filing because most literary organizations that could fit this classification file as educational organizations instead. Generally, groups that sell books promoting the public interest, at or below cost, and available to the general public, qualify as groups organized for literary purposes.

Application for Federal Tax-Exemption

There are four publications and forms available from the IRS that should be used to apply for 501(c)(3) tax exemption:

• Application for Recognition of Exemption (Form 1023)

• User Fee for Exempt Organization Determination Letter Request (Form 8718)

• Application for Employer Identification Number (Form SS- 4)

• Tax-Exempt Status for Your Organization (Publication 557)

Qualifying for State Tax-Exempt Status

Although Texas does not have an income tax for either individuals or corporations, corporations are subject to a franchise tax. As a result, many nonprofit corporations are interested in obtaining exemption from state taxes as well as federal taxes. An organization that is exempt from federal income tax is not automatically exempt from state tax. It must separately apply for exemption from Texas taxes. However, federal exemption is required for exemption from the Texas tax. To apply for exempt status in Texas, a corporation should submit a request for exemption to the Comptroller for Public Accounts, along with a copy of its articles of incorporation, a copy of the determination letter granting federal exemption, and a copy of the corporate bylaws.

For additional information on Texas associations and nonprofit corporations, contact the Texas Secretary of State, Corporation Division, P.O. Box 13697, Austin, TX 78711, (512) 463-5586, fax (512) 475-2761.

Associations and nonprofits that are interested in additional information on the federal tax rules for exempt status should contact the Internal Revenue Service, (800) 829-3676. For more information on exemption from Texas taxes, contact the Comptroller of Public Accounts, 111 East 17th Street, Austin, TX 78711, (800) 252-5555.

Additional resources on associations and nonprofits generally can be found in:

• Marcia L. Clifford et al., Nonprofit Organizations: Forms for Creation, Operation and Dissolution (Callaghan & Company, Wilmette, IL 1987)

• Anthony Mancuso, How to Form a Nonprofit Corporation (Nolo Press, Berkeley, CA, 2d ed. 1994)

• Barbara Singer, Nonprofit Organizations: Operations Handbook for Directors and Administrators (Callaghan & Company, Wilmette, IL 1987)