Steps to Incorporation--Chapter 2 of The Nonprofit Handbook

While incorporation is a legal procedure, it does not require the services of a lawyer. However, lawyers with training and experience in state nonprofit law can be useful in reviewing, if not preparing, Articles of Incorporation and bylaws that are consistent with both statutory requirements and the purposes of the organization.

State libraries, law school libraries, and many public and private libraries have a set of books that have all of the state laws codified by topics that typically include “corporations.” Make sure in researching current law to refer to the most up-to-date supplement for use in the current year. This supplement will include all changes made to state laws since the law books were first printed.

Incorporators are those persons legally responsible for forming the corporation. It is common for one person to serve in this capacity, although several people may sign the Articles of Incorporation form as formal incorporators. Some states require more than one incorporator (see the state directory of this book).

Incorporators frequently play a more active role than solely being a name on the Articles of Incorporation filing. If they act to promote the interests of the new corporation (e.g., raise funds, recruit personnel, negotiate leases, or purchase property for the organization), their legal status is augmented by the responsibility of serving in a fiduciary capacity. This legal status confers on them the duty to take actions in the best interest of the corporation rather than their own personal interest, and to disclose any conflicts of interest that may occur in their business dealings on behalf of the corporation.

By law, the incorporators make agreements on behalf of the corporation while it is in the process of legal formation. These agreements have no legal effect until they are approved by the corporation’s board of directors, once the corporation legally exists. As a result, incorporators who make these agreements must make it clear to the other party that the agreement is not binding until the corporation exists as a legal entity and its board ratifies the agreement.

Once the Articles of Incorporation are filed and the state government agency with jurisdiction over incorporation (usually the Department of State) approves them, incorporators have no formal status, with one exception. They are invited to be present at the organizational meeting required by law, at which the board of directors is selected.

It is a common practice that the incorporators include members who will be serving on the first board of directors. Thus, care should be taken as to the qualifications of incorporators, since they may continue their association with the corporation as directors.

One of the most important and basic decisions in forming a corporation is choosing a corporate name. This name will be the organization’s corporate identity, and the image created by it provides the first impression held by those outside of the corporation. “Short” and “descriptive” are two desirable characteristics in a corporate name. Many nonprofit organizations choose a name that gives the connotation of helping, or otherwise doing charitable activities in the public interest, rather than implying a for-profit motive.

If the organization plans to apply for 501(c)(3) status, it should avoid names that would be suitable for organizations whose activities are clearly not eligible for this status. The organization may wish to consider suitable acronyms comprising the first letter of each word of its name, but cute or frivolous acronyms often give an unprofessional impression. It is useful to check if any other organization is using the prospective name by using Internet search engines and the U.S. Patent and Trademark Office’s database (see below).

The process of having to change a corporate name after incorporating and operating as a nonprofit often results in time-consuming and costly activities, such as changing the logo (see Chapter 24); reprinting stationery, business cards, checks, and brochures; and changing all of the legal forms relating to Articles of Incorporation, bank accounts, and contracts.

For obvious legal reasons, the name must be unique in the state of incorporation, although it is usually legal to adopt a name similar to another existing corporation after receiving permission from that corporation and filing the necessary forms to do so. Typical state laws permit the name to be in any language, but require that it be expressed in English letters or characters. For more information about the limitations on corporate names, consult the state directory of this book, and call the contact office with specific questions.

A name search should be performed with the state agency of jurisdiction to ensure that no other corporation, active or inactive, is using an identical or similar name. Almost every state permits the name to be reserved for a modest fee prior to incorporation, typically for a 120-day period.

Many corporations also choose to do a national name search and take steps to register their names with the United States Patent and Trademark Office as trademarks. This can be done only for those organizations that will be marketing goods and services interstate. The fee is $375 for paper filing and $325 for electronic filing using the Trademark Electronic Applications System (TEAS), which provides registration for ten years, assuming the owner certifies that the trademark has active status. See: http://www.uspto.gov/main/faq/index_feefaq.html for requirements to be eligible for a $50 discount by filing a TEAS Plus form. Obviously, if an organization has trademarked its name, it is not available for other organizations, even if that organization is headquartered in another state.

For more information or to obtain the correct forms, contact the Patent and Trademark Office:

U.S. Patent and Trademark Office (USPTO)

Commissioner for Trademarks

U.S. Department of Commerce

PO Box 1451

Alexandria, VA 22313

(571) 272-1000

(800) 786-9199

Web site: http://www.uspto.gov/trademarks/teas/index.jsp

Basic information about trademarks can be accessed at:

http://www.uspto.gov/

It is generally advisable to state broad corporate purposes in a manner that permits the corporation to grow and change direction without requiring its Articles of Incorporation to be amended. However, the purposes should be specific enough to permit the corporation to be eligible for 501(c)(3) status, if this is expected.

The Internal Revenue Service (IRS) has provided guidance on drafting a purpose statement that will facilitate a successful 501(c)(3) eligibility determination. Two examples illustrate clauses that will satisfy the IRS:

“1. charitable and educational purposes within the meaning of IRC 501(c)(3).

“2. To grant scholarships for deserving junior college students residing in Gotham City.”

“To operate a hospital” is an example of a purpose that is unacceptable to the IRS. The explanation provided by the IRS is that the purpose is ambiguous, since a hospital may be exempt or not exempt, depending upon how it is operated.

The IRS provides language that nonprofit organizations may use in their Articles of Incorporation if they choose a broad corporate purpose consistent with the first example:

This corporation is organized exclusively for one or more purposes as specified in Section 501(c)(3) of the Internal Revenue Code or the corresponding section of any future federal tax code, including, for such purposes, the making of distributions to organizations that qualify as exempt organizations under Section 501(c)(3) of the Internal Revenue Code, or the corresponding section of any future tax code. The corporation shall not carry on any other activities not permitted to be carried on by a corporation exempt from Federal income tax under 501(c)(3) of the Internal Revenue Code of 1954, as amended (or the corresponding provision of any future United States Internal Revenue law).

A second consideration when devising the purpose statement to facilitate exemption is to provide that the organization benefits an indefinite class of individuals, not specific persons. For example, if the purpose of the organization is intended to be establishing a scholarship fund for specific members of a family who were orphaned by the September 11th World Trade Center disaster, the purpose should be “to grant scholarships to deserving American students orphaned by terrorist attacks” rather than “to grant scholarships to the children of John A. Smith.”

Research similar organizations and review their Articles of Incorporation to obtain ideas on framing your own organization’s Articles of Incorporation. Some states have limitations on how broad these purposes can be in the Articles (see state directory beginning on page 289).

“Membership” in the legal sense has a different meaning than those in an organization who pay dues. In the context of incorporation, having members refers to providing broad governance authority beyond an organization’s board of directors. In general, it is desirable for most nonprofit corporations to have no members. This will ensure that all power and authority will be maintained by the board of directors, and it will prevent the difficult legal problems of expelling an individual member should that occasion arise. It is also expensive and time-consuming to conduct elections, change bylaws, and make major organizational decisions when all members have the legal right to participate. Outsiders, including those who would pay dues in exchange for participating in organizational programs and activities, can still participate in the activities of the nonprofit corporation without being legal members who are entitled to vote on the affairs of the corporation.

As with almost every issue, there are exceptions to this. Many organizations will find it desirable for each participant in the organization’s programs and activities to have an equal voice in the internal governance of the organization. Many individuals bristle at the fact that a nonprofit organization’s governance is often controlled by a self-selected group of individuals that sometimes are perceived by members to be elitist, paternalistic, or secretive about the organization’s affairs. Some feel that having legal members is more egalitarian and democratic.

Many corporations that wish to qualify for 501(c)(3) status add a provision that will facilitate tax-exemption approval. One such provision is a statement forbidding the corporation from engaging in partisan political activity on behalf of, or in opposition to, a candidate or substantially engaging in lobbying. The language for this provision can be adopted from 501(c)(3) itself:

No substantial part of the activities of the corporation shall be the carrying on of propaganda, or otherwise attempting to influence legislation, and the corporation shall not participate in, or intervene in (including the publishing or distribution of statements) any political campaign on behalf of any candidate for public office except as authorized under the Internal Revenue Code of 1954, as amended.

A second provision required for Section 501(c)(3) eligibility relates to corporate dissolution:

Upon the dissolution of the corporation, assets shall be distributed for one or more exempt purposes within the meaning of Section 501(c)(3) of the Internal Revenue Code, as amended or supplemented, or shall be distributed to the federal government or to a state or local government for a public purpose. Any such assets not so disposed of shall be disposed of by the District Court of the county in which the principal office of the corporation is then located, exclusively for such purposes or to such organization or organizations, as said Court shall determine, which are organized and operated exclusively for such purposes.

A third provision required by the IRS for Section 501(c)(3) eligibility relates to private inurement. All states require similar language as a condition for incorporating as a nonprofit:

No part of the net earnings of the corporation shall inure to the benefit of, or be distributable to, its members, trustees, officers, or other persons, except that the corporation shall be authorized and empowered to pay reasonable compensation for services rendered to the corporation and to make payments and distributions in furtherance of the purposes set forth herein.

Once the Articles of Incorporation are filed and approved, be sure that all actions taken on behalf of the Corporation will clearly indicate that they are actions for the corporation and not on behalf of individuals. Otherwise, such individuals may be personally liable for fulfilling the terms of contracts and other agreements, such as paying rent, staff salaries, telephone installation costs, and so on. One way to indicate that persons are acting on behalf of the corporation is to explicitly sign legal contracts and other documents as follows:

(corporate name)

By (individual’s signature)

(individual’s corporate title)