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Incorporated vs Unincorporated

The basic difference between a nonprofit being incorporated (also called a “corporation”) or unincorporated is whether it files formation paperwork with its state. Only incorporated nonprofits need to file formation documents. A corporation is normally preferable to an unincorporated association because, in most states, corporations provide a personal liability shield to insiders (directors, officers, and members), whereas an unincorporated association does not.

What is an Unincorporated Nonprofit Association?

The definition of an unincorporated nonprofit association is when two or more people come together to work toward a common not-for-profit goal. In the sense of a 508, that common goal is for religious, educational, and charitable purposes. 

Incorporated or Unincorporated, Compliance Is Key

  • Incorporated: Forming your 508 as a nonprofit corporation involves paperwork and ongoing maintenance to comply with regulatory rules. Your nonprofit corporation must comply with regulartory rules of the Nonprofit Corporation Act (or similar) in your state.
  • Unincorporated: No legal paperwork needs to be drawn up or filed for the organization to be considered an unincorporated association.
  • Federally: Your 508 will need to operate within the compliance set forth for churches, assocations of churches, conventions of churches, or integrated auxiliaries of churches according to 26 U.S. Codes § 501(c)(3), 508(c)(1)(A), 6033(a)(3)(A)(i), 170(b)(1)(A)(i), 509(a)(1), and other relevant Codes. Operating a noncompliant 508 carries potentially serious consequences. We want every 508 to be confident and ready if the IRS ever comes knocking for information or it becomes necessary to defend your organization’s tax-exempt status in court. And considering our nation’s current political climate, this unfortunately may happen sooner rather than later—hence the importance of being prepared!

Liability Protection for Incorporated Nonprofits

The benefits of incorporating as a nonprofit corporation, which stem from its legal characterization as a separate entity, include:

  • Liability protection. You and your fellow association members are not exposed to the potential personal liability that you would have if your group continued to function as an unincorporated association. Even though some states, such as California, provide a certain amount of liability protection for unincorporated association members, it’s still not as strong as the liability protection obtained through incorporation.
  • Contracting with third parties. A nonprofit corporation is able to contract directly with suppliers, financial institutions, and other organizations or individuals. With an unincorporated association, one or more of the association’s members must personally enter into such contracts.

Liability Protection for Unincorporated Nonprofits

  • 18 States (Alabama, Colorado, Delaware, Hawaii, Idaho, Indiana, Louisiana, North Carolina, Ohio, Texas, West Virginia, Wyoming, Arkansas, Iowa, Kentucky, Nevada, Pennsylvania, and Washington D.C.) have adopted the Uniform Unincorporated Nonprofit Association Act (UUNAA) or Revised UUNAA.
  • This Act reforms the common law concerning unincorporated nonprofit associations in three basic areas – authority to acquire, hold, and transfer property, especially real property; authority to sue and be sued as an entity; and contract and tort liability of officers and members of the association.
  • “A debt, obligation, or other liability of an unincorporated nonprofit association whether arising from a contract or tort is solely that of the association and does not become that of its members solely by virtue of their status as members.” – Uniform Unincorporated Nonprofit Association Act (2008) (Last Amended 2011)

Liability Examples

Imagine a nonprofit holds a fundraiser dinner. Someone attends the dinner, slips and falls, and is seriously injured. The family sues the nonprofit, and the court awards the family $10,000,000. At this time, the corporation has total assets of $100,000.

In the case of an unincorporated association, the nonprofit would pay out all $100,000 and close down. This leaves a balance of $9,900,000. Since insiders of an unincorporated association are usually jointly and severally liable for the acts of the association, each director, officer and member could be personally on the hook to pay the full amount.

In the case of a properly run corporation, the nonprofit would pay out all $100,000 and close down. However, because the hallmark of a corporation is to limit the liability of its insiders, the directors, officers and members will be shielded from personal liability for the balance. Too bad for the family, they only get $100,000.

The Model Nonprofit Corporation Act (MNPCA) was approved by the Business Law Section of the American Bar Association in 1964 and has since been revised three times, most recently with the fourth edition, which was approved in 2021 and published in 2022. 37 out of the 50 states have adopted a version of the MNPCA. The Revised Model Act (RMNPCA) has been adopted, in whole or in part, in Arkansas, Indiana, Mississippi, Montana, North Carolina, South Carolina, Tennessee, Washington, and Wyoming. Other states have not explicitly adopted either version of the model act but may borrow provisions from the model legislation.

Another source of law governing nonprofit entities appears in the form of the Uniform Unincorporated Nonprofit Association Act (UUNAA), which was approved by the National Conference of Commissioners on Uniform State Laws in 1996. The UUNAA governs all unincorporated nonprofit associations that are formed or operate in a state that adopts the act. Alabama, Colorado, Delaware, Hawaii, Idaho, Indiana, Louisiana, North Carolina, Ohio, Texas, West Virginia, and Wyoming, have enacted a prior version of the UUNAA while Arkansas, Iowa, Kentucky, Nevada, Pennsylvania, and Washington D.C. have enacted the Revised UUNAA.

As far as the states that have not adopted the MNCA or the UUNAA, they follow for-profit business law for the state for Unincorporated Nonprofit Associations.

“The I.R.S. examined 1.4 million individual income tax returns in 2010, about 1 percent of the total number filed. In 2018, the latest year with available data when Republicans started making these claims, audits decreased to 370,000, or about 0.2 percent… The budget office estimated increasing I.R.S. funding would return enforcement to its 2010 levels. Doing so would result in about 1.2 million more audits; of those, 583,000 would target people making less than $75,000.”

The New York Times, “Fact-Checking the Misleading Claim About 87,000 Tax Agents”, November 6, 2022

“…For example, you educate believers on national issues that are central to their belief in the Bible as the inerrant Word of God. Specifically, you educate Christians on what the bible says in areas where they can be instrumental including the areas of sanctity of life, the definition of marriage, biblical justice, freedom of speech, defense, and borders and immigration, U.S. and Israel relations. The bible teachings are typically affiliated with the Republican party and candidates. This disqualifies you from exemption under IRC Section 501(c)(3).”

Stephen A. Martin, IRS Director, Exempt Organizations, Rulings and Agreements