What other legal structures are there for nonprofits? What about fiscal sponsors?

During your planning phase, you may determine that an alternative legal structure is better suited to your organization’s needs. In addition to forming a nonprofit corporation as described in “How do we form a nonprofit organization?”, there are four common alternatives.

  1. You can form an unincorporated association.
  2. You can form a limited liability company.
  3. You can be incubated by a fiscal sponsor.
  4. You can become affiliated with another nonprofit.

While the law does not require organizations to be incorporated in order to be eligible for tax exemption, unincorporated associations cannot offer protection against personal liability to directors and members. In addition, while there may be fewer reporting requirements of unincorporated associations, many foundations are not willing to fund them.

Technically speaking, a nonprofit can be formed as a limited liability company, or LLC. As of 2004, this is legal in California and qualified organizations can gain tax-exempt status. However, the requirements to gain federal 501©(3) status as an LLC frequently disqualify many interested organizations. IRS regulations prohibit individuals as members of the LLC and only allow members that are themselves exempt organizations. In other words, your organization would already have to be a legally recognized 501©(3) in order to apply for federal tax-exempt status as an LLC.

Fiscal sponsorship is an approach that allows an organization with 501©(3) status to extend its legal status to another organization (or initiative or project). Many such organizations offer administrative support and technical assistance to help advance an organization’s goals, generally at low cost. This option provides an opportunity to grow your start-up project and legally accept grants and donations without the red tape associated with establishing a stand-alone entity. Once your program is established, it can transition from the incubator to become a freestanding organization.

Affiliation with an existing nonprofit is another option that may be available to you. If your mission and goals align closely with those of another organization, affiliation may be a wise choice. Potential benefits include a ready source of clients, access to knowledgeable staff and a “home” for your program. When looking at this option, you should consider how well the affiliate’s goals match those of your program, as well as the level of autonomy your program or organization will have within that structure. Also look at the strength of existing relationships with the board, director and staff, and the impact of any financial arrangements you’ll make.

There are many other types of federally exempt organizations allowable by the IRS. For a complete list, refer to IRS Publication 557, Tax-Exempt Status for Your Organization. When choosing a legal structure for your organization, it’s highly recommended that you consult with an attorney experienced in tax and corporate law governing nonprofit organizations.

You should also know that there are many other types of for-profit and profit/nonprofit hybrid structures that vary from state to state. For example, several states allow for the creation of low-profit limited liability companies, or L3Cs, to meet the needs of social ventures. Another option is a B Corporation, which is structured to create benefit for both society and shareholders.

Legal FAQ

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