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Corporations 101: California Entities Simplified (Unincorporated Associations)

orming an Unincorporated Association

While many nonprofit associations benefit from forming nonprofit corporations, small, local, or labor organizations tend to prefer an unincorporated association format. Local musical, religious, or literary clubs, for example, may not have the financial or human resources to obtain and maintain nonprofit status. Nonprofit corporation status, discussed below, tends to be advantageous to larger groups with activities and relationships external to the organization. Small charitable organizations, such as family trusts, do not seek public funds or otherwise deal with people or organizations outside of the association. These organizations would not benefit from nonprofit corporation status, and incorporation would add additional and unnecessary legal requirements and possible liability.

Unincorporated Association Law

Just because an association takes a less formal approach to its formation does not mean that it should grow haphazardly. Members of unincorporated associations should be aware that without some formal planning, associations risk running afoul of the law. Early organization becomes particularly useful once an association starts to grow in membership and resources.

Articles of Association

Every association should have articles of association. Sometimes referred to as the charter or the constitution, the articles of association is the document containing a statement of the association's purpose and an outline of the procedures it will follow. Some states require an unincorporated association to file its articles of association with the secretary of state, the county clerk, or another state or local agency.

Becoming a Tax-Exempt, Nonprofit Corporation

Forming a tax-exempt, nonprofit corporation is a fairly complex endeavor that requires time, money, and an understanding of legal and tax technicalities--all of which may be scarce in organizations that would most likely benefit from tax-exempt treatment and nonprofit status. Still, the benefits available to nonprofits are so great that it often is worth the time and energy to become familiar with the necessary steps. Some of the rules governing how a nonprofit corporation must be formed and operated are complex. The process of becoming a tax-exempt, nonprofit corporation actually has two distinct phases: (1) creating the nonprofit corporation, and (2) applying for tax-exempt status for the corporation once it has been created. The chronology of these two phases is important. The second phase--applying for tax-exempt status--will be far simpler for organizations that keep that goal in mind during the first phase.

Benefits of Tax-Exempt, Nonprofit Status

The primary benefits of tax-exempt, nonprofit status are financial. All or most of the money made by a tax-exempt, nonprofit corporation is free from federal, state, and local taxation, so the organization can devote a larger share of its funds to the purpose for which it was formed. Furthermore, nonprofit status is often a prerequisite to obtaining private grants or government funding. Donors are more likely to contribute financially to tax-exempt, nonprofit corporations than to non-exempt organizations because donors can write off the donations on their tax returns. In addition to tax benefits, there may be low-cost postage and advertising rates available to nonprofit organizations, and many retail stores offer reduced rates to nonprofits and their employees. As with all other businesses, nonprofits are open to lawsuits and liability for the way they conduct themselves. Organizing as a not-for-profit corporation can shield the individuals who run the organization from personal liability for organizational debts.

The often-overlooked advantages of forming a tax-exempt, nonprofit organization are the internal benefits that the organization gains when required to commit to writing its management structure and corporate purpose. Many nonprofits start out as a small group of committed persons working toward a definite goal. Having to think through the organization's purposes and management procedures can bring clarity, focus, commitment, and structure at an early stage in the organization's life. These qualities can be invaluable as the organization grows, takes on new projects, and adds new members, or if internal disputes arise.

Drawbacks of Tax-Exempt, Nonprofit Status

Just because an organization qualifies for tax-exempt, nonprofit status does not mean that seeking nonprofit status is the best plan. Tax-exempt, nonprofit status does have drawbacks:

Profits of the organization cannot be divided among workers or directors (although workers and directors may be paid reasonable salaries)

Only a small amount of the group's income can be earned from sources unrelated to the organization's reason for receiving tax-exempt status

The assets of the group cannot go toward purposes other than those that warranted the tax-exempt status

Many businesses do not take advantage of tax-exempt, nonprofit status because they prefer the flexibility and the possibility of personal financial gain associated with for-profit status. Other organizational leaders opt not to incorporate in order to avoid the paperwork. For a very small organization that does not need donations or that has few tax obligations, forming a nonprofit corporation and seeking tax-exempt status may be more trouble than it is worth.

Nonprofit Corporations in California

Most nonprofit corporations in California are governed by the Nonprofit Corporation Law, with administrative authority granted to the Secretary of State. Under this law, a nonprofit corporation may be formed for a wide variety of purposes, but nonprofit corporations generally are divided into three categories: public benefit corporations, mutual benefit corporations, and religious corporations. Public benefit corporations may be formed for any public or charitable purpose. Mutual benefit corporations may be formed for any lawful purpose.

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