Who Profits When Nonprofits Die

April 10, 2006
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GRAND RAPIDS — In the for-profit business world, when a corporation ceases to exist, there usually aren’t too many piles of money left to divide up. When there are, the ownership model of the corporation pretty clearly dictates where those left-over assets go. But what happens when a nonprofit organization, for reasons other than financial insolvency, chooses to disband? What happens to the organization’s assets when the organization is no more?

Amie Vanover is an attorney who specializes in nonprofit law for the firm of Warner Norcross & Judd. She explained that, in the case of common 501(c)(3) nonprofits, the rules are pretty clear.

“These are organizations that apply to the IRS for tax-exempt status. And to get that status, the IRS has several rules that these organizations have to follow. One of these rules is that you have to satisfy what’s called the ‘organizational test,’” she said. “The idea is that in your bylaws and in your articles, you need to have language stating that upon dissolution, your assets can only go to one or more charitable purposes or to the government for one or more public purposes.”

That is the general framework. Beyond that, Vanover said, there is a lot of room for variation. A great deal depends on the particulars of a group, its donors and the circumstances under which it chooses to dissolve.

For example, the Ladies Literary Club of Greater Grand Rapids has decided to disband after more than 130 years of operation. Despite dwindling membership and several years of operating losses, the club has no debt and retains assets of more than $400,000, according to 2005 tax documents. Chief among the club’s assets is a 119-year-old stone “Richardsonian Romanesque-style meeting house,” as the building is described on the national historical register. In October 2005, then-president Nancy Wright told the Business Journal that the club was looking to sell the building.

Rosemary Van Houten, a representative of the club’s transition committee, said that the future of the organization’s assets is wrapped up in the sale or transfer of the building.

“We’ve had plenty of discussions and ideas about that. It depends on who gets the building, of course,” she said.

That highlights one of the variables in the tax code. As Vanover mentioned, the IRS code requires that an organization identify in its articles of incorporation and its bylaws how its assets would be distributed in the event of dissolution. It does not, however, require that the specifics of that distribution plan be put in place until the actual dissolution is imminent. In other words, the articles of incorporation might say that a nonprofit would pass along its assets to other organizations with similar missions, but it would not be required to name who those organizations are.

“Generally people leave it open,” said Vanover. “The idea, typically, is that the trustees will make the decision where those assets will go.”

In some instances, those decisions are already made. When assets are required as “restricted gifts,” the nonprofit cannot dispense with them freely; it must abide by the boundaries set by the donor.

“When people give assets to charity, they don’t always just give an asset and say, ‘Do whatever you want with it, charity. It’s yours,’” said Vanover. “Other times it might be a conditional gift where it’s supposed to be used for a particular purpose, and if not it comes back to the donor.”

These restrictions represent a bit of a gray area in the law. Vanover said that the restrictions and conditions placed upon gifts are not always legally enforceable. When there is a written contract associated with a donation, the rules are clear. In other cases, it is simply the goodwill of the beneficiary organization that ensures that the gift is used as intended.

For example, Nonprofit A is forced to dissolve because of dwindling enrollment. It decides to pass along its assets to Nonprofit B. Among those assets is a conditional gift which is to be used to fund children’s art programs. Nonprofit B doesn’t do art programs, so it decides to use the funds for other purposes. If the gift made to Nonprofit A was formalized in a written agreement, the donor or its heirs could rescind the gift. If there is no such written agreement, Nonprofit B would be able to do as it pleases.

“There are legal rules, and then there are practical consequences of what you can get away with,” she said.

In most cases, dissolving nonprofits find a way to ensure that any restricted gifts continue to be used for their stated purpose. That usually means finding the right beneficiary organization and trusting its leaders to use the assets appropriately.

“The nonprofit corporation is no longer around. Of course the nonprofit cares about its assets. They were formed to do good in the community. They want their promises to be continued,” Vanover said. “But their biggest concern is following the IRS rules in dissolving. And for their purposes, they’ve done their job.” 

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