Nonprofit organizations function differently than for-profit enterprises, and therefore encounter different legal issues and concerns. The most important characteristic that differentiates nonprofit organizations from for-profit enterprises is the fact most but not all nonprofit organizations are tax-exempt organizations. Tax exemption is granted by the IRS, which imposes an additional level of legal compliance. In addition to tax status, nonprofit organizations tend -but are not required- to be funded by charitable giving or charitable activities. This connection between charitable donations and giving, and the operations of nonprofit organizations, results in legal issues related to fundraising, charitable giving, charitable fundraising regulation, as well as state-level attorney general protection over charitable fundraising activities. Another legal aspect that nonprofit organizations face is grappling with interactions with the people being served by the work of the nonprofit, as well as the volunteers who might be participating in the delivery of such work. Even though nonprofit organizations tend to have unique legal issues not experienced by for-profit enterprises, generally nonprofit organizations are still businesses that operate within the same stream of activity as for-profit businesses. Nonprofit organizations still have employees, rent office space, and deal with the purchase of goods and services by vendors and other parties.

Social enterprises – businesses that are in the stream of economic activity but have a mission broader than just profit – can be structured many different ways. When I work with social entrepreneurs on structuring their social enterprise, I help these entrepreneurs buildout an entire business plan for their social enterprise.  Through the process of building out a business plan, we can discover what legal structure is best: a for-profit enterprise such as an LLC or a corporation, a benefit corporation, or a nonprofit corporation. I ask social entrepreneurs to consider the following questions:

• Is your proposed business selling a good or service that will be purchased by consumers or other businesses?
• Who is going to pay for the good or service that the proposed business is offering? The person who is receiving it; another party who is donating money to pay for the good or service to be delivered to another person; or the government?
• What sources of funding are available to start this social enterprise? Money from investors. Grant dollars from foundations. Donated dollars from people interested in the work of the social enterprise?
• If the answer to the first questions are that the social entrepreneur knows there are grant dollars for donated dollars available to start and operate the proposed business, ease the proposed activity charitable, or is otherwise able to qualify for tax exemption by the IRS
• Does the proposed social enterprise require tax exempt charitable status to do the work proposed? If the answer is yes (for whatever reason) then we advise social entrepreneurs to form a nonprofit enterprise that can obtain tax exempt status.

Typically, after working through the business planning questions, we do not recommend the social enterprise be formed as a nonprofit corporation. If the nonprofit entity doesn’t work for the social enterprise than we look at traditional for-profit entities or benefit corporations.

A B–Corp (or more formally a Certified B-Corporation) is a for-profit enterprise, either an LLC or corporation, that has been certified by the nonprofit organization B-Lab as a B-Corp.  To be certified, as a B-Corp,the business needs to complete B-Lab’s B Impact Assessment.  The Assessment is administered online and is open to any business that wants to complete the Assessment.  If the business achieves a high enough score on the B Impact Assessment, the business can be certified by B-Lab as a B-Corp.  B-Lab charges a fee for the certification and allows businesses certified by it as a B-Corp that can use the B-Corp logo.  Certified B-Corps must repeat the Assessment periodically to maintain certification as a B-Corp.

In contrast a benefit corporation is a state law business “structure” available for social entrepreneurs that want to form a benefit corporation as the type of business it forms.  Not every state in the US has benefit corporation laws so the ability to form a benefit corporation is not available to all social entrepreneurs.

Regardless of form – Certified B Corp or Benefit Corporation – both business structures (or certifications) require the business enterprise have and operate with more than just a purpose to earn a profit for the enterprise’s owners.   Often these purposes are referred to as either a triple or quadruple bottom-line.

The answer to this question depends on the market positioning of the business and the expectation of the owners of the business.

It goes without saying that customer-facing businesses such as goods or services sold to the public in a retail setting, might find a tremendous advantage to be either a benefit corporation or a Certified B Corp.  As consumer tastes and practices change, consumer products in the businesses that sell them may need to change to continue to attract customers. The best way to think about this advantage is to look at one of the oldest social enterprises — Newman’s Own brand products.  Directly on its package labeling Newman’s Own proclaims that “100% Profits to Charity” since 1982.  Newman’s Own more than likely found customers for a salad dressing because of this proclamation. Modern social enterprises structured either as a Benefit Corporation or Certified B Corp do more (or less) than just give away profits to charities.   Many make commitments such as sourcing through free trade, acting in a way that protects the environment, or employing members of the workforce who are challenged (such as veterans, developmentally disabled adults, etc.).  People like to buy products from businesses that help others.

From the business owner’s perspective – shareholders, members, partners, etc. – if a social purpose is important to the activities of the business enterprise, having either a Benefit Corporation or becoming a Certified B-Corp ensures owners that management of the business will operate the business in accordance with these ideals.

Only for-profit enterprises can be Certified B-Corps and generally, under most state laws, only corporations (not Limited Liability Companies or cooperatives) can elect to be Benefit Corporations.

The primary disadvantage to B-Corps or Benefit Corporations is the lack of understanding about how and what they are. Many people assume (wrongfully) that the enterprise that elects to be certified as a B Corp or become a Benefit Corporation has elected to make no profit or low profit, to the disadvantage of those who invest in these types of enterprises. This is a misunderstanding. The decision to become either a certified B Corp or a Benefit Corporation does not eliminate the opportunity for the business to do well.  Many profitable for-profit enterprises have taken the benefit route and are profitable, with their investors receiving a healthy return on their investment.

Another disadvantage of the current options for benefit corporations is that we cannot take advantage of the LLC structure because state laws generally do not allow for the formation of Benefit LLC’s. In many startup business situations, the LLC is the best structure because it provides the entrepreneur with some tax advantages.  Because benefit corporations are limited to a corporate structure, some of the more aggressive tax planning available with the LLC is just not there. While we can make the S Corp election for a benefit corporation, the selection limits the ability to raise capital from outside investors.

Nonprofit organizations, social enterprises and cooperatives are all businesses operating within our economy. As businesses they have the same legal needs as any other type of business. They enter into contracts, they buy and rent real estate, they pay taxes, they have employees, they can sue and be sued, and they can be bought and sold. When serving as an Outside General Counsel for a nonprofit social enterprise or cooperative we often deal with the same issues we deal with for other businesses. But because of the unique legal nature of nonprofit organizations, social enterprises and cooperatives, when we serve as Outside General Counsel, we always need to keep in mind these unique characteristics and provide legal advice and services that take these into account and do not create additional problems.  For example, when you serve as Outside General Counsel for a nonprofit organization that is hiring or firing its executive director, you need to have a strong understanding of nonprofit corporate law and any limitations imposed by the IRS on hiring and firing of key employees of a tax-exempt organization.  Outside General Counsel who does not have the special awareness of these additional legal frameworks would be challenged to provide competent legal advice to a nonprofit organization.  Similarly, while serving as Outside General Counsel for cooperatives, we must always be aware of the unique realities of cooperatives such as democratic voting (one member one vote) and certain exemptions from antitrust and securities laws.

A nonprofit organization generally needs to be formed as an entity. That is not true in every state. In order for a nonprofit organization to obtain tax-exempt status from the IRS, the organization must be set up as a corporation, community chest, fund, or foundation to qualify for tax exemption. A charitable trust set up as a fund or foundation will qualify. What is most important is that an individual will not qualify for tax-exemption. 

No. A nonprofit organization’s assets must be permanently dedicated to an exempt purpose stated in the organizing documents of the nonprofit organization and listed in Section 501(c)(3) of the Internal Revenue Code. The exempt purposes are charitable, religious, educational, scientific, literary, testing for public safety, fostering national or international amateur sports competition, and the prevention of cruelty to children or animals. The term charitable, according to the IRS, includes relief of the poor, the distressed, or the underprivileged; advancement of religion; advancement of education or science; erection or maintenance of public buildings, monuments, or works; lessening the burdens of government; lessening neighborhood tensions; eliminating prejudice and discrimination; defending human and civil rights secured by law; and combating community deterioration and juvenile delinquency. When applying for (and maintaining) tax-exemption, a nonprofit organization must fit within these proscribed purposes.  

Once an asset is contributed to or made part of the assets of a tax-exempt charitable organization, those assets must be permanently dedicated to an exempt purpose. When a nonprofit organization winds-up or dissolves, its assets must be distributed to another organization that has an exempt purpose or to the federal or state government for a public purpose. The organizing documents should include a clause that ensures the distribution of assets upon dissolution to a 501(c)(3) organization. Even if a nonprofit’s organizing documents do not include this clause, most state laws that govern nonprofit organizations include this requirement.  

Exclusive operation for an exempt purpose means that the nonprofit organization must engage primarily in the activities that fulfill the 501(c)(3) exempt purposes listed. If the organization only “insubstantially” engages in those activities, then it will not be considered tax-exempt. For example, if an organization engages in business activities to raise funds, they must be relatively insubstantial to the tax-exempt purposes and must primarily advance the public benefit, not any individuals’ private interests.  

Yes. A nonprofit organization must operate for the public benefit, which means it must actually operate and not lie dormant for any substantial amount of time. Leaders of nonprofits that actively maintain programs and services must be consistently mindful of this operational test.

Charitable, religious, educational, scientific, literary, testing for public safety, fostering national or international amateur sports competitions, and preventing cruelty to children or animals.

United State law “defines” charitable as the relief of the poor, the distressed, or the underprivileged; advancement of religion; advancement of education or science; erecting or maintaining public buildings, monuments, or works; lessening the burdens of government; lessening neighborhood tensions; eliminating prejudice and discrimination; defending human and civil rights secured by law; and combating community deterioration and juvenile delinquency. While these categories of activities seem very specific, they are actually very broad in practice. For example, delivering meals to the elderly (sometimes generically referred to as Meals on Wheels) is charitable under several categories – relief of the distressed as well as lessening the burdens of government. The elderly and children are considered a “charitable class” for many purposes that has nothing to do with wealth or means. These groups of people fall into a charitable class because culturally and historically, the care and well-being of both children and the elderly is considered a societal obligation.  

No. A 501(c)(3) tax-exempt organization cannot be operated for the benefit of private interests. This prohibition prevents the organizer, organizer’s family, members or other individuals from receiving any benefits generated by the activities of the nonprofit organization. This prohibition on monetary benefits (or profit) going to any individual is a fundamental tenant of nonprofit tax-exempt organization law and is where the term “nonprofit” comes from. Nonprofit does not mean that a nonprofit tax-exempt organization cannot make a profit; it means that no individual can profit from the organization.