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Volunteer Legal Handbook
Section IV 
Creating a Nonprofit Corporation

IV. Creating a Nonprofit Corporation

At least in a limited sense, creating a nonprofit corporation is a form of risk management. While the corporate veil may protect the members under some circumstances, it doesn't always work and, in any event, does nothing to protect the nonprofit corporation or its mission.

Creating a nonprofit corporation is neither simple nor straightforward; while it is easy enough to create a corporate shell, creating a nonprofit corporation that operates effectively and appropriately for your organization can be pretty complex.

You should always involve a lawyer in the creation of a nonprofit corporation; if you seek charitable corporation status, you will probably also want to involve a certified public accountant familiar with nonprofit tax laws.

For these and the reasons described below, creation of a nonprofit corporation tends to be issue-specific. Please treat this chapter as setting out only broad guidelines.

If you aren't interested in creating a nonprofit corporation yourself, it's probably okay to skip this chapter...

A. Determining Whether to Incorporate

Not every nonprofit organization needs to or should incorporate. Incorporation adds to the expenses of operation, imposes additional duties and risks on the managers of the nonprofit organization, and exposes the nonprofit organization to additional regulation. But in many cases incorporation is the only reasonable option. Some of the factors to consider include, but are not limited to:

1. Fund-raising requirements

There is no question but that being a charitable corporation for tax purposes gives an organization a tremendous advantage in fund-raising efforts. Depending upon the income tax bracket of a private donor, being a charitable corporation can save the donor 28-38% of his money by permitting payment with "pretax" dollars. And to be a charitable corporation, you have to first be a nonprofit corporation.

2. Requirements imposed by third parties

Many foundations, governments and other entities, either by law or policy, will only deal with nonprofit corporations. If you want a grant from the Alaska Division of Family & Youth Services, or the National Science Foundation or whoever, you may very well have to be a nonprofit corporation.

3. Continuity of existence

A nonprofit corporation gives an organization continuity of existence; that is, the organization may out-live its organizers. A partnership or association may cease to exist as a matter of law when its organizers cease to exist or to be involved.

4. Management of large numbers of members

A membership nonprofit corporation provides an organizational structure that is well-documented, legally well-understood and well known to most persons, since it derives from the for-profit corporate model. That can be a big advantage in dealing with larger numbers of persons.

5. Risk management

This is not usually a very good reason to incorporate. While a nonprofit corporation operates as a kind of "poor man's insurance," it is not a substitute for insurance or risk management. Generally, insurance premiums tend to be smaller than the true cost of creating and maintaining a nonprofit corporation. In addition, the corporate veil that makes a nonprofit corporation moderately useful as a risk management device has a distressing tendency to fail just when you need it the most.

6. Eventual dissolution

If you can see a time when the nonprofit corporation will no longer be needed, then you need to consider the costs of dissolving or otherwise terminating the nonprofit corporation.

7. Alternate forms of organization

While a nonprofit corporation is by far the most common means of organization, and is the focus of these materials, it is not the only vehicle available. In appropriate circumstances, a trust might be more appropriate, or even a limited liability company organized under AS 10.50.010 et seq. Note: a limited liability company may be organized for "any lawful purpose," AS 10.50.010, without any specific requirement that it be a for profit purpose. However, the creation of one of these alternate forms of structure is beyond the scope of these materials.

B. Selecting the Nonprofit Corporate Structure

There are two broad sorts of nonprofit corporation structures: membership nonprofit corporations and non-membership nonprofit corporations.

1. Membership nonprofit corporations

In a membership nonprofit corporation, the members of the nonprofit corporation select the board of directors. Members are roughly analogous to shareholders in a for-profit corporation, except that members may not participate in the "profits" or otherwise receive special benefits from the nonprofit corporation. Members may have other rights if those rights are described in the Articles of Incorporation or in the bylaws. However, generally Alaska law and the IRC prohibit members from receiving special benefits because of their status as members, especially in the case of charitable corporations.

2. Non-membership nonprofit corporations

Alaska nonprofit corporations are not required to have members. AS 10.20.051. If there are no members, then existing directors on the board of directors select their successors.

C. Obtaining a Certificate of Incorporation

A certificate of incorporation is a piece of paper. It is not a lawful, operating nonprofit corporation. Rather, think of it as proof that the persons who are named as the initial board of director have the permission of the State of Alaska to create a corporation. It is a crucial step to creating a nonprofit corporation, but it is by no means the last step.

1. Articles of incorporation

You obtain a certificate of incorporation by filing verified articles of incorporation with the appropriate filing fee at the State of Alaska. Send them to:

Department of Commerce & Economic Development
Corporations Section
PO Box 110807
uneau, Alaska 99811

There are provisions that must be in the articles and, in addition, you can add other provisions, subject to the limits of the law.

a) Mandatory provisions

The following mandatory provisions must be in the Articles of Incorporation for your nonprofit corporation:

(1) Name of the nonprofit corporation

The name must not contain any phrase or part that suggests the nonprofit corporation was created for any purpose except those set out in the Articles of Incorporation. The name must not be deceptively similar to that of another corporation or registered business name. You can check available names at

Corporations Section, 907-465-2530, or at its World Wide Web site, available on-line at:

http://www.commerce.state.ak.us/com/owa/comdata.bsc

(2) Duration of the nonprofit corporation

Ordinarily, the duration of a nonprofit corporation is perpetual. But sometimes a nonprofit corporation might only need to have a limited existence. For example, the nonprofit corporation that coordinated the 50th anniversary of the construction and completion of the Alaska Highway had a limited duration.

(3) Purpose or purposes

The Articles of Incorporation must describe with some specificity the purpose or purposes for which the nonprofit corporation is created. Note that to qualify as a tax exempt or charitable corporation the Internal Revenue Code severely limits the permitted purposes.

(4) Control of the nonprofit corporation

The Articles of Incorporation must address provisions for internal control of the nonprofit corporation. For example, the Articles might be drafted to provide for management by a board of directors selected by the members according to terms set out in the bylaws, and for bylaws to be adopted or amended by the board of directors, subject to approval by the members. While the internal management must be addressed, you have considerable flexibility in deciding how to do so.

(5) Distribution of assets on dissolution

As a matter of both Alaska law and the Internal Revenue Code, you must describe what happens to the assets of the nonprofit corporation in the event the nonprofit corporation is dissolved. It is imperative that the Articles provide that no part of the assets go to members or directors for the nonprofit corporation simply because of their status. Ideally, the assets should be distributed to another nonprofit corporation with a similar purpose.

(6) Initial board of directors

An initial board of directors must be named in the Articles of Incorporation. These are the persons who conduct the first of the series of organizational meetings. Usually, but not always, these are the incorporators, the persons who sign the Articles of Incorporation. You must set out both the name and the mailing address of each initial director. Usually, you must have three initial directors.

(7) Registered agent and registered address

The nonprofit corporation must name a person who is authorized by the nonprofit corporation to receive notices, lawsuits, orders and other official documents affecting the nonprofit corporation. That person must also provide an address. The nonprofit corporation should give careful thought as to who is named as registered agent; they must be responsible enough to always forward the notices to a current officer who can act upon them.

For example, if the nonprofit corporation is sued, the summons and complaint may be mailed or personally served on the registered agent. The nonprofit corporation has a limited time &emdash; typically 20 - 23 days &emdash; to answer the summons and complaint, If the nonprofit corporation fails to timely answer, the nonprofit corporation will lose the lawsuit by default. If the registered agent isn't being conscientious, the nonprofit corporation could lose a lawsuit it didn't even know had been filed.

b) Permissive provisions

These are any number of additional issues you may want to set out in your Articles of Incorporation. Some examples are provided here. There is no statute which sets out what is prohibited to be set out in the Articles. But state and federal law severely limit some things that would be permissible in the for profit sector.

Some nonprofit corporations also use the Articles of Incorporation to set out provisions which are already in the statutes, but are so important that they want the members and directors to always be aware of them. For example, a nonprofit corporation cannot make loans to directors. By setting it out in the Articles of Incorporation, it's harder for the directors to "lose sight" of the provision.

(1) Officer and director immunity

By statute, a nonprofit corporation may limit the liability of directors and officers by adopting specific language in the articles of incorporation. Unless the limitations of liability are in the articles, the protection granted by statute is not available. There are two broad drawbacks to adopting those limitations on liability. First, it's a little awkward for officers and directors to immunize themselves from the consequences of their own conduct. Second, the immunity is limited in scope. Officers and directors remain liable for their actions and inactions in the areas described below. See generally Section II(E)(4) above, addressing this issue in the context of amendments to existing articles of incorporation.

(a) Breach of the duty of loyalty

A breach of the director's duty of loyalty to the nonprofit corporation cannot be excused, and to the extent a director violates the duty of loyalty he will remain liable even if the statutory immunity has been put in place. An example: a director who is on the board of two different nonprofit corporations applying for the same grant has hopelessly compromised his duty of loyalty. No matter which nonprofit gets the grant, the other can accuse him of a breach of his duty of loyalty.

(b) Acts not in good faith

A director is liable for acts or omissions not in good faith or that involve intentional misconduct or a knowing violation of law. To the extent a director is not acting in good faith, or knowingly violates the law, she will remain liable even if the statutory immunity has been put in place. An example: a director who agrees to accept a donated painting, in return for agreeing the painting has a value higher than an appraisal shows, has engaged in a knowing violation of the law, and will be liable.

(c) Improper personal benefit

A director will be liable for a transaction from which the director derives an improper personal benefit, even if the statutory immunity has been put in place. An example: a director who is also an insurance agent, and writes insurance policies for the nonprofit corporation, and receives a commission, has derived an improper personal benefit.

(2) Procedures for selection of directors

You may choose to provide in your Articles of Incorporation for the manner in which directors are elected, whether or not you have members.

(3) Different classes of membership

If you have members, you can provide for different classes of members. For example, your nonprofit corporation might want to have voting members and non-voting members.

(4) Adoption and amendment of bylaws

The bylaws, discussed below, are the operating rules for the nonprofit corporation. Sometimes control of a nonprofit corporation is an important issue; one means of limiting the power to change the balance of power is to provide that the bylaws of the nonprofit corporation can only be amended with the approval of the members, or by a supermajority of the members.

2. Certificate of incorporation

The certificate of incorporation issued to you by the State of Alaska is an important document. It is your "charter," as it were. It should be stored in a safe and secure place.

D. Implementing the Nonprofit Corporation

Obtaining a certificate of incorporation is only the first step in the process of creating a nonprofit corporation. It creates a skeleton of a nonprofit corporation. Implementing the nonprofit corporation puts some meat on the skeleton and creates an operational entity.

1. Record-keeping

It's difficult to overstate the importance of complete and accurate record keeping for nonprofit corporations. Record keeping serves two very important purposes.

a) Proving what happened

In the eyes of the law, a nonprofit corporation is a person, almost like you or me, except that you cannot tap it on the shoulder. In order for the "person" to be able to prove it did something, there is going to have to be a writing. The testimony of a witness about what happened is not particularly persuasive and, in any event, it may be impossible to find the person who actually has the knowledge to testify long after the fact. For example, the minutes of a meeting of members or the minutes of a meeting of the board of directors needs to be sufficiently specific and detailed to allow each person in attendance to be able to establish with reasonable certainty what occurred at the meeting.

b) Institutional memory

The memory of a nonprofit corporation is only as good as its senior-most officer, director or member. By writing things down, you help maintain the collective memory of the nonprofit corporation, its "institutional memory." A few years after the fact the current board of directors should be able to find out why a former board of directors took the action that it did.

2. Organizational meetings

The organizational meetings of a nonprofit corporation are a series of meetings in which the nonprofit corporation "bootstraps" itself into existence. These meetings may seem a series of silly formalities, but they establish that the nonprofit corporation was properly created. It is critical that the meetings be documented in order to establish that the nonprofit corporation was duly, lawfully and properly created. The following flowchart sets out the order of the organizational meetings:

a) Meeting of initial board

The Articles of Incorporation establish the members of the initial board of directors. These are the persons charged with the initial creation of the nonprofit corporation: the first of the steps involved in implementing the nonprofit corporation. Typically, the initial board of directors takes the following actions at the meeting.

(1) Interim bylaws

The initial board must provisionally adopt interim bylaws under which it operates. These are almost always identical to the bylaws that will be finally adopted.

(2) Creation of interim officers

If the nonprofit corporation is to have members and the provisional bylaws provide for a certificate or other proof of membership, or if there are other acts which at this stage require an agent to act on behalf of the nonprofit corporation, then the initial board of directors must elect provisional officers, persons authorized to act as agents of the partially organized nonprofit corporation.

(3) Creation of members

If the nonprofit corporation will have, then the initial board will act to create those members. Otherwise, the initial board of directors selects the members of the first board of directors.

(4) Transfer of assets

Sometimes an existing association moves its activities to the new nonprofit corporation. If that is to happen, usually it happens at the Initial Board of Directors meeting.

b) Meeting of members

If the nonprofit corporation has members, the next organizational meeting is that of the members. If the members have the right to select the board of directors, they elect the directors of the nonprofit corporation. The members might also ratify the actions taken by the incorporators and the initial board of directors.

If there are no members, the Initial Board should select the directors.

c) First meeting of board of directors

After the meeting of the Initial Board and the meeting of the members (if there are members), there will be persons who have been selected as directors. Some of the issues that the board of directors might consider are described below.

Note that the board of directors is a long-term, ongoing body, while the Initial Board of Directors meets only one time.

(1) Adoption of bylaws

The board of directors adopts permanent bylaws, usually the same as those adopted provisionally by the initial board of directors, as described above.

(2) Ratification of prior actions

The board of directors should review the actions taken by the incorporators and the initial board of directors. If the actions were all appropriate, the board of directors should ratify &emdash; adopt and approve &emdash; those earlier actions.

(3) Election of officers

Now that there are bylaws and assets, the nonprofit corporation can elect officers for the nonprofit corporation. Sometimes the bylaws provide for the members to elect officers, although it's not clear that Alaska law permits members of a nonprofit corporation to elect the officers. You should consult your lawyer about those issues. But if, as is typical, the bylaws provide for election of the officers by the board of directors, then that action should be taken at the first meeting of the board of directors.

Under Alaska law, a nonprofit corporation, at a minimum, must have a president and a secretary, and they may not be the same person. A nonprofit corporation may have as many additional officers as it chooses.

(4) Commence nonprofit activities

Once the nonprofit corporation has bylaws setting out the rules under which it will operate, a board of directors to set policy and exercise overall control, and officers to implement that policy, it is ready to conduct its activities. Remember that those activities are closely limited and scrutinized as described in these materials, by the Internal Revenue Code and by the State of Alaska.

E. Nonprofit Corporate Bylaws

The bylaws of a nonprofit corporation tend to be fairly specific to the organization. It's difficult to develop "generic" bylaws. But here are some issues to consider for the bylaws for your nonprofit corporation. Note that your nonprofit corporation must have bylaws of some kind.

1. Important provisions

The following are some of the more important issues to consider addressing in your bylaws. As to all of these examples, you will want to consult with a lawyer familiar with nonprofit corporate law for assistance in keeping your bylaws consistent with Alaska law.

a) Membership and annual meetings

If the nonprofit corporation is to have members, the bylaws should provide for the terms under which persons may become and remain members of the nonprofit corporation. The terms under which an annual meeting or special meeting of the members will be held should also be addressed.

b) Directors and meetings

The bylaws should address the procedures for the qualification, selection and term of members of the board of directors of the nonprofit corporation. The bylaws should also describe the manner in which notice of a regular or special meeting of the board of directors will be held, and what will constitute a quorum at such a meeting.

c) Officers and duties

The kinds of officers and their duties should be set out. The procedures for the qualification, selection and term of each officer should be set out.

d) Standing committees

If the board of directors or members want standing or permanent committees created, describe them in the bylaws. Example might be a finance committee, a risk management committee or an executive committee.

e) Amendment of the bylaws

Describe the procedures under which the bylaws may be amended. Will you allow the board of directors to amend them? By what vote? Or will membership approval of amendments be required.

f) Conduct of meetings

It's prudent to provide something to the effect that, where not inconsistent with the bylaws and Articles, Roberts Rules of Order will govern meetings of members and directors.

2. Other possible provisions

Here are some other matters you might want to address in nonprofit corporation bylaws.

a) Conflicts of interest

Conflicts of interest, as described throughout these materials, are a real problem and can create liability under many circumstances. You might want to set out a conflict of interest policy. The legal minimum policy is at Section II(E)(5), pages 69-71 above.

b) Nepotism

"Nepotism" occurs when family members work under the supervision of another family member. It's not illegal but it does present a variety of risks. You might want to consider adopting nepotism guidelines or rules.

c) Books and records

You might want to address where records will be stored, how long they will be preserved before being destroyed, and who may have access to them and under what terms. You might also want to address who signatures are required on a check, letter or other document to create corporate action.

F. Obtaining Tax Exempt Status

A nonprofit corporation is not automatically exempt from payment of income taxes on its income. The nonprofit corporation must comply with Federal law &endash; specifically, the Internal Revenue Code and regulations &endash; to obtain tax exempt status.

You should involve an accountant or other professional familiar with nonprofit corporations from the outset as you seek to obtain your tax exempt status. But you can help yourself by obtaining from the IRS a copy of its Publication No. 557 (Rev. Jan 92) titled "Tax-Exempt Status for Your Organization."

1. IRS Form 1024

Unless your nonprofit corporation is a foundation or a charitable corporation under Section 501(c)(3) of the Internal Revenue Code, you will likely need to use Form 1024 to apply for tax exempt status. There is a table at the back of Publication 557 which describes which specific IRS Form to use.

G. Obtaining Charitable Organization Status

Just because a nonprofit corporation has tax exempt status, as described in the preceding section, it does not follow that it is a charitable corporation for purposes of the Internal Revenue Code. To become a charitable corporation you must also obtain status as a charitable corporation under the Internal Revenue Code.

You should involve an accountant or other professional familiar with nonprofit corporations from the outset as you seek to obtain your charitable organization status. But you can help yourself by obtaining from the IRS a copy of its Publication No. 557 (Rev. Jan 92) titled "Tax-Exempt" Status for Your Organization."

1. IRS Form 1023

Even by IRS standards, IRS Form 1023, the "Application for Recognition of Exemption Under Section 501(c)(3) of the Internal Revenue Code" is extremely challenging to complete. In particular, you will want to proceed carefully as you show that you are not creating a "private foundation" under Internal Revenue Code Section 509 (unless that is your intent).

a) When to apply

The simple answer is as soon as possible. If you submit the application within 15 months of the date on which the nonprofit corporation was "organized" then the effective date of the charitable corporation status is the date of organization. It gets much more complicated if you wait more than 15 months.

2. IRS Form 8718

Your application for charitable corporation status seeks a "determination letter" from the IRS which is your proof of charitable corporation status. To obtain a determination letter you must also submit Form 8718, which is essentially the transmittal form for a hefty fee. Without a Form 8718 and the required fee, the IRS will not consider your application.

H. Maintaining a Nonprofit Corporation

A nonprofit corporation requires maintenance and ongoing support to function. At one level, there are reports to be filed, and the failure to file those reports can seriously affect the nonprofit corporation. At another level, the failure to keep minutes, or to preserve the distinction between the nonprofit corporation's assets and those of its directors and members, or the failure to comply with tax law requirements, can cause the nonprofit corporation to cease to exist.

If, unwittingly, the nonprofit corporation is permitted to cease to exist, or loses a part of its status as a tax-exempt or charitable organization, the consequences can be very serious, not just for the nonprofit corporation but for the officers and directors who permitted that to happen. Here are some of the things you must do to maintain the existence of the nonprofit corporation.

1. Biennial reports

The nonprofit corporation must file a biennial report with the Department of Commerce and Economic Development. The failure to timely file a biennial report can result in the involuntary dissolution of the nonprofit corporation. The Department of Commerce and Economic Development will mail a biennial report form to the registered agent described in the Articles of Incorporation (or any amendment). Obviously, it is important to have procedures in place that assure the form of biennial report is timely forwarded to the secretary or other designated officer of the nonprofit corporation, completed and filed.

2. Annual meetings

If the nonprofit corporation has members, then the nonprofit corporation is required to hold an annual meeting of those members. It is important to document that such an annual meeting occurred. Be certain that minutes are taken and preserved.

3. IRS reports

Depending upon the kind of tax status enjoyed by the nonprofit corporation, the IRS may impose reporting duties and obligations. Just because a nonprofit corporation is tax exempt does not mean it is excused from filing tax returns. See the discussion at required reports. The kinds of reports tend to be specific to the tax status of the nonprofit corporation. You should consult with an accountant or other professional familiar with nonprofit corporations about the reporting requirements imposed on your nonprofit corporation. In many cases, the failure to timely file required reports can result in stiff penalties or even loss of tax exempt status.

a) Annual return

Presently, most tax exempt nonprofit corporations must file IRS Form 990 annually. There are some exceptions, especially for churches.

b) Unrelated business income

If your nonprofit corporation has unrelated business income, you must also file Form 990-T.

c) Political activities

If your nonprofit corporation spent any amount on political activities, your nonprofit corporation may also have to file Form 1120-POL.

d) Fund-raising activities

If your nonprofit corporation has engaged in fund-raising activities, it may face additional reporting requirements. See generally IRS Form 8282 (Donee Information Return), Form 8283 (Noncash Charitable Contributions), Form 8300 (Report of Cash Payments Over $10,000) and Publication 561 ("Determining the Value of Donated Property").

I. Ending a Nonprofit Corporation

If a nonprofit corporation is inactive or is no longer needed, or for some other reason is not operating or about to cease operations, you should consider whether and how to formally end the life of the nonprofit corporation. You cannot simply "walk away" from the nonprofit corporation. To do so exposes the officers and directors to liability to the government, creditors, members and others. There are fairly detailed procedures which must be followed, including a "plan of dissolution" and "articles of dissolution," a kind of mirror image of the articles of incorporation which created the nonprofit corporation. Remember that assets must be distributed in compliance with Alaska law, state and Federal tax law and consistently with the corporate purposes of the nonprofit corporation.

If your nonprofit corporation fails to file its biennial reports, the Department of Commerce & Economic Development will involuntarily dissolve your nonprofit corporation. In the wrong circumstances, that can be disastrous.

You should consult an attorney familiar with nonprofit corporate law to review how to end a nonprofit corporation.

 

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