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Dissolving a 501(c)(3) Nonprofit: A Comprehensive Guide

Dissolving a 501(c)(3) Nonprofit: A Comprehensive Guide

The decision to dissolve a nonprofit organization is often a challenging and emotional process for all involved.  There could be any number of reasons why the decision is made:  financial difficulties, fulfillment of mission, lack of participation, or even a pandemic!  It’s crucial (no matter the reason) for the board of directors, members (if any), and other key individuals to approach dissolution with a clear understanding of the legal requirements and best practices to ensure a smooth process.

This guide outlines the steps involved in dissolving a 501(c)(3) nonprofit, highlights areas of concern, and discusses the potential risks.

Understanding the Dissolution Process

Dissolution of a nonprofit organization involves a series of legal and operational steps designed to responsibly close operations, settle debts, and distribute any remaining assets.  Given the public interest nature of nonprofits, these steps are regulated to protect the assets that have been dedicated to public use.  And in the case of a 501(c)(3), those assets are dedicated to a charitable purpose, not just a public one.

Each state has their own rules governing final dissolution, and we cannot address every contingent possibility in this short article.  With that in mind, here are the universal steps to follow in order to wind down and dissolve a nonprofit.

Step 1: Board Decision and Member Approval

The first step in dissolving a nonprofit is for the board of directors to adopt a resolution to dissolve.  This decision should be made during a formally convened meeting of the board, ensuring quorum requirements are met, as spelled out in the organization’s bylaws.  The resolution to dissolve should be documented in the meeting minutes and MAY require approval by a vote of the organization’s members.

This may seem obvious, but requires being said:  Member ratification of a proposed dissolution is only required for organizations with a membership vested with voting rights.  Sometimes the requirement for member approval is specifically outlined in the bylaws; sometimes it’s not.  You should also consult state nonprofit corporate law regarding member rights on these matters.

Step 2: Filing the Notice of Intent to Dissolve

Once the resolution to dissolve has been adopted, the nonprofit must file a notice of intent to dissolve with the state’s Secretary of State, or other body regulating nonprofit corporations in that state.  This filing, which often involves a fee, officially starts the dissolution process and may trigger the requirement to notify creditors and other stakeholders of the organization’s intent to dissolve.

Step 3: Settling Debts and Obligations

Before final dissolution, the nonprofit must settle its debts and fulfill its obligations.  This includes paying off all liabilities, cancelling any leases or contracts, and ensuring that all employee-related obligations (if any), such as final payroll and benefits termination, are handled appropriately.

In extreme situations, a terminating nonprofit may find itself hopelessly in debt with no financial ability to pay its creditors.  In this case, it may be necessary to file for bankruptcy before any actual dissolution paperwork is filed.

Step 4: Distributing Remaining Assets

After settling debts, any remaining assets must be distributed in accordance with the organization’s purpose and state laws.  This can look different depending on the tax-exempt category of the nonprofit.

In the case of a 501(c)(3), the IRS requires assets to be distributed to another 501(c)(3) organization or for other overtly charitable purposes.  In fact, the IRS takes this element so seriously that it requires all 501(c)(3) organizations to have this provision in their Articles of Incorporation.

Other tax-exempt entities have different distribution requirements.  In the case of most 501(c)(7) organizations, remaining assets are distributed to the members pro-rata to their interest in the whole.

The plan for distributing assets should be detailed in the dissolution resolution or in a separate plan that the board adopts.  Some states, like our home state of Tennessee, require nonprofits to submit a separate notice of asset distribution to the Attorney General’s office.

Step 5: Final Federal and State Filings

The final step in the dissolution process involves completing and filing final tax returns with the IRS and the state.  This includes filing Form 990 with the “Final Return” box checked and attaching a copy of the dissolution documents.

Additionally, state-specific reports and filings related to the dissolution must be completed.  Since this varies widely by state, it is critical to seek the counsel of a competent professional who has experience with nonprofit dissolution in your state.

Best Practice Considerations
  • Early Planning:  Begin planning for dissolution well in advance to ensure a thorough and complete process.
  • Transparency:  Maintain open communication with stakeholders, including employees, donors, and beneficiaries throughout the dissolution process.  Don’t forget that for many, there is a lot of emotion and attachment involved when a cherished entity winds down.
  • Legal and Financial Consultation:  Engage professionals early in the process to navigate these complex regulations and filings.
  • Document Everything:  As we say with so many issues we discuss, keep meticulous records of all decisions, meetings, and communications related to the dissolution.
Areas of Concern
  • Asset Distribution:  Improper distribution of assets can lead to legal challenges.  Ensure that the distribution plan complies with state laws and aligns with the nonprofit’s mission.
  • Creditor Notifications:  Failing to properly notify creditors could result in legal liabilities for board members.
  • Employee Rights:  Ensure that all employee-related issues, such as final paychecks, benefits, employments taxes, insurance, etc. are handled in accordance with state and federal laws.
  • IRS:  Simply forgetting to mark “Final Return” on your post-dissolution Form 990 can cause major headaches.  The last thing you want after dissolution is getting a late return notice from the IRS when you are thinking that all loose ends are tied up.
  • DISSOLUTION IS FINAL!  This part is essential to understand.  Once you go through the steps to dissolve, the organization will legally cease to exist.  There’s no bringing this particular entity back to life.  If you ever decide to jump back into something like this, it will have to be with a brand new organization.
Potential Risks
  • Legal and Financial Liability:  Board members could face personal liability if the dissolution process is mishandled, especially regarding creditor notifications and asset distribution.
  • Reputational Damage:  Poor handling of the dissolution process can harm the reputations of the nonprofit and its board members, affecting future endeavors.
Conclusion

Dissolving a 501(c)(3) nonprofit organization is a complex process that requires careful planning and execution.  It is also one that is fraught with personal attachment, emotion, and potential grief.  By understanding the steps involved, adhering to best practices, and being aware of potential pitfalls, board members can navigate this challenging journey responsibly and respectfully.

It’s always advisable to seek professional advice to ensure compliance with all legal and financial obligations, protecting the interests of all stakeholders involved in the nonprofit’s mission.

It’s a sad day when a nonprofit can no longer continue its mission.  But by winding down well, the process doesn’t have to be an unnecessarily painful one.

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Greg McRay is the founder and CEO of The Foundation Group. He is registered with the IRS as an Enrolled Agent and specializes in 501(c)(3) and other tax exemption issues.

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