Many so-called nonprofits are simply small groups of people who come together temporarily to perform some social good. They might raise money for a limited purpose such as helping a neighbor or sending the local high school band to a competition. Some groups simply bring in such limited income that a formal business model may not be necessary.
An Unincorporated Nonprofit Association
Legally, an unincorporated nonprofit association forms whenever at least two people agree to pursue a common lawful purpose that is not for profit. If the endeavor is for profit, it is called a partnership or joint venture.
You have probably been part of an unincorporated nonprofit association if you joined a few other people to help raise money for a family affected by a catastrophe. You may not even be aware that you were part of a legal association because your intention was merely to help someone out temporarily. You and your neighbors came together to accomplish a good deed and then went your separate ways.
These informal groups are called unincorporated nonprofit associations. They usually come and go as needed. However, if that group or association continues indefinitely, it may be subject to certain legal requirements, even though it hasn't filed for incorporation under its state's incorporation laws. For example, an unincorporated association may need to file tax returns, whether as a taxable or tax-exempt entity. Additionally, some states have registration requirements.
There may also be multiple state and local registration requirements no different from a similar nonprofit corporation, such as charitable solicitation registration, out-of-state qualifications to do business, and local business registration.
If your informal association continues for a period of time or plans to keep up its charitable activities, legal experts recommend registering with the Secretary of State even if not required and fulfilling other registration requirements such as applying for an Employer Identification Number (EIN) to open a bank account.
There are, however, generally minimal legal requirements concerning corporate formalities and governance under state law for unincorporated nonprofit associations. Thus, setting up this type of organization may be a good alternative to a more formally organized and registered 501c3.
The Disadvantages of an Unincorporated Nonprofit Association
Members of an unincorporated nonprofit association may be exposed to personal liability for the obligations of the association if state laws do not explicitly provide for limited liability (for example, California provides for limited liability for members of an unincorporated nonprofit association).
Regardless, the law is still less certain regarding personal liability as compared to corporations. Therefore, an unincorporated association may not be ideal if the group's activities might create concerns about contract or tort liability (two common areas where liability issues arise), or if potential members, board members, and supporters might be deterred by such concerns.
An unincorporated association can operate as a tax-exempt nonprofit as long as the purpose of its activity is of public benefit, and annual revenues are less than $5,000. If the association remains small with limited income, the unincorporated association does not need to apply to the IRS for 501(c)(3) status.
The Advantages of Incorporating
As a practical matter, however, the group may want to consider incorporating at that point. The IRS will want to see certain documents even if not required by state law (for instance, organizing documents), and will also be checking for common governance issues such as compensation practices and conflict of interest procedures.
Also, without a determination letter from the IRS, it may be difficult to get donations and almost impossible to get grants. Foundations almost always require 501(c)(3) status before providing money to nonprofits.
It may also be difficult to enter into contracts with some other entities (for example, too many risks for the other party without extensive due diligence). The group will also need to check the requirements for obtaining tax-exempt status on the state level.
Although there may be no need to file for tax-exemption under 501(c)(3) if the association has annual gross receipt of normally not more than $5,000, it must still annually file Form 990-N with the IRS.
Unincorporated nonprofit associations work best for informal, ad hoc situations where people get together to perform some community service or raise funds for a particular, and usually short-term, goal.
If an organization is not ready to file for 501(c)(3) status from the IRS, an alternative may be to seek a fiscal sponsor. A fiscal sponsor is another nonprofit that can "mentor" a startup or small non-exempt organization until it becomes ready to file for its own exemption.
Note: This article incorporates information provided by Emily Chan, a San Francisco-based attorney specializing in nonprofits. It is not intended to be legal advice. It is advised that you consult your own attorney regarding your particular situation.