Which Form Should a 501(c)(4) Take?

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As defined under section 501(c)(4) of the Internal Revenue Code (IRC), a social welfare organization is an entity operated without profit and exclusively for the promotion of public welfare. Qualified social welfare organizations can be exempted from federal and state income taxes. Before going through the process to qualify for tax-exempt status, an organization first needs to be organized under state law. The IRC allows three types of entity to qualify under 501(c)(4): unincorporated associations, corporations, and trusts. There are pros and cons to organizing using these different forms.

  1. Unincorporated associations

Of the three forms, an unincorporated association is the simplest to establish, because its existence relies solely on the behavior of its organizers. Under California law an unincorporated association comes into being as soon as two or more people are “joined by mutual consent for a common lawful purpose.” When a nonprofit’s organizers begin activities as a group, they likely are already operating as an unincorporated association, whether they know it or not.

Organizations that proactively choose to operate as unincorporated associations will want to register their organization with the Secretary of State and will need to take steps to secure tax exemptions from the state and IRS. Before pursuing any significant activities that may give rise to liability, the organization will also need to adopt governing documents that will allocate responsibilities between managers and members and, among other things, define the organization as a nonprofit.

An unincorporated nonprofit association’s members enjoy a degree of limited liability for the debts and obligations of the organization. By default, a “member” is someone who participates in selecting managers, officers, and directors. One reason that many organizations opt to incorporate is to gain the more robust liability protections offered by the corporate form.

  1. Corporations

Most nonprofit corporations in California are organized as public benefit corporations. This type of corporation is subject to specific rules about how it is organized and governed. Unlike an unincorporated association, a corporation only exists after it has filed articles of incorporation with the state. It must also adopt certain governing principles (bylaws) and must appoint at least one director.

The key advantage of organizing as a corporation is that the corporate form provides a robust shield for members and managers against being held personally responsible for the debts and obligations of the organization. Although the form may have substantially similar tax consequences when compared to an unincorporated association, the extra liability protection makes it a worthwhile choice for organizations that will take on anything more than very small, low-risk activities.

  1. Trusts

Trusts are a type of legal entity that usually are set up by individuals for tax planning reasons. A trust’s specific form depends on the particular requirements of the person setting up and funding the trust (the “grantor”). To work as a nonprofit, a trust must be organized to be irrevocable, meaning the money and other assets placed into it can’t be taken out other than to perform charitable purposes or distribute them to other nonprofits. A grantor is allowed to manage the assets of the trust in accordance with the trust’s governing document. When a charitable organization is set up as a trust it typically is organized as a private foundation.

In many practical ways a trust is similar to a corporation, insofar as it can have a board of directors, officers, and a slate of governing documents that have many features in common with those of a corporation. However, a trust is subject to different tax rules which may or may not be advantageous to an organization’s fundraising and operational plans.

The Church Law Center works with religious and secular nonprofits

The Church Law Center of California provides legal counsel to a wide range of clients in the nonprofit sector, including 501(c)(4) organizations. We can help your group explore the different structures available to it and get started with the process of setting up shop. Call us at (949) 689-0437 or reach out to us through our contact page.

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