Nonprofit Corporations Overview
Just like any other form of entity, a nonprofit corporation is recognized at both state and federal levels. At the state level, chapter 22 of the Texas Business Organizations Code (TBOC) covers essential aspects of structure and governance for nonprofit corporations. At the federal level, a nonprofit corporation can be recognized as an exempt organization under the provisions of section 501(a) of the Internal Revenue Code (IRC).
Of the twenty-nine forms of exempt organizations under the IRC, twenty-five are under section 501(c), one is under 501(d), and one is under 501(e). Other than 501(c)(3) charitable organizations, the most common are 501(c)(4) for civic leagues and social welfare organizations; 501(c)(6) for business leagues, sports leagues, and chambers of commerce; and 501(c)(7) for social and recreational clubs.
This chapter in this manual largely covers nonprofit corporations under section 501(c)(3) that are tax-exempt for the following purposes: charitable, religious, educational, scientific, literary, testing for public safety, fostering national or international amateur sports competition, and preventing cruelty to children or animals. These types of entities are also known as “charitable organizations” and are the most popular and common form of exempt organization at the federal level because they typically allow donors to take tax deductions for charitable contributions.
PRACTICE TIP: Tax exemption under state and federal laws is not automatic with nonprofit corporation formation. Exemption must be applied for at both the state level (with the Texas Comptroller of Public Accounts) and the federal level after the corporation is approved by the secretary of state. Certain types of nonprofit corporations (for example, churches and religious places of worship, primary and secondary schools, and disaster relief organizations) may also apply for exemption from property taxes assessed by local taxing units such as cities, counties, and school districts.
Texas recognizes a nonprofit corporation as the only form of incorporated entity eligible for exemption under state law. An unincorporated association may also be recognized as a nonprofit; however, as the name implies, it is not a corporation and thus is outside the scope of part V.
One important distinction between a nonprofit corporation and any other form of entity (for example, a corporation, limited liability company, or limited partnership) is that the nonprofit corporation does not allow any part of its income to be distributable to any members, directors, or officers (see the definition of “nonprofit corporation” under section 22.001 of the TBOC). No persons may own any equity in a nonprofit corporation, and there is no “owner” of a nonprofit corporation beyond the concept of a “public benefit” for a particular purpose set out in the corporation’s governing documents. In fact, dividends are expressly prohibited for a nonprofit corporation under section 22.053 of the TBOC.
On the other hand, a nonprofit corporation is permitted to pay compensation to its directors, officers, employees, and other persons, as long as that compensation is reasonable. Further, a nonprofit corporation is allowed to confer benefits to the corporation’s members in conformity with the corporation’s purposes (for example, prayer space, intangible religious benefits to members of a church or similar place of worship, or access to educational resources to students). Special rules permit liquidating distributions to members upon dissolution, particularly to members that are 501(c)(3) nonprofit corporations themselves.
PRACTICE TIP: “Nonprofit” corporation is a bit of a misnomer. It is not that these forms of entities do not make a “profit” in a financial sense from their operations or investments—it is just that those profits are not distributed to any person, except in the form of reasonable compensation and benefits for exempt purposes. Some of the wealthiest entities in the United States are nonprofit corporations (for example, churches with property holdings and private schools and universities). Note, however, that profit earned through the “commercial business” of a nonprofit corporation may be subject to unrelated business income tax at rates similar to those levied on for-profit corporations.
A nonprofit corporation is governed by its board of directors. Under Texas law, a nonprofit must have a minimum of three directors. The board is appointed and maintained from the formation of the corporation throughout its setup, growth, and maintenance until its dissolution. The board is assisted by officers; a nonprofit corporation in Texas must have a president, secretary, and treasurer at a minimum, and the president and secretary have to be separate persons.
Some nonprofit corporations allow for one or more classes of members that are typically empowered to elect all or some of the directors and officers. See Tex. Bus. Orgs. Code § 22.151. Some nonprofit corporations do not have provisions for members, and thus the board of directors is empowered to increase, decrease, or replace board members or to fill vacancies on the board. Voting can be done by single vote for each position, or even cumulatively if set out in the corporation’s governing documents.
PRACTICE TIP: It is important that the founders of a nonprofit corporation consider from the outset whether the entity will have members. While this decision can be changed, doing so later requires a higher threshold of votes, and the entity must file an amendment with the secretary of state to recognize the change. In addition, provisions should be included for selecting replacement candidates as soon as possible after seats become available.
§ 20.1Nonprofit Corporation Formation (State Level)
A nonprofit corporation is formed by filing a certificate of formation that conforms to Texas Business Organizations Code (TBOC) requirements with the secretary of state (SOS Form 202, www.sos.state.tx.us/corp/forms/202_boc.pdf). In particular, the certificate must be in writing, submitted by the duly authorized organizer(s), and signed by an organizer. The nonprofit corporation’s certificate of formation typically differs from those for LLCs and other entities by being customized to contain language relating to tax exemption issues. Once formed, the nonprofit corporation can begin transacting business in the state of Texas like any other entity (subject to obtaining a license to do business).
The name of the nonprofit corporation must appear on the certificate of formation. Texas law does not require nonprofits to include “corporation,” “incorporated,” or similar designations in their names, but some organizers prefer to include them or their abbreviations to show the incorporated nature of the entity. The certificate of formation must also include the purpose for which the corporation is organized; this language is scrutinized by the IRS during its tax exemption application process (detailed later in this chapter). In addition, for IRS satisfaction, the certificate of formation needs to include certain language limiting the rights of profits, prohibiting other actions by persons, or both. The final required language relates to dissolution and distribution of assets upon winding up and the permitted scope of such actions by a nonprofit corporation.
PRACTICE TIP: Search for similar entities on the secretary of state website. Their certificates of formation will contain language that has already been approved for tax exemption at the federal, state, and other levels of government. This language can be set out in your entity’s governing documents to ensure it is approved for tax exemption. In some instances, this language can also be found on the organization’s website or on third-party websites like Charity Navigator’s. It is important to use these precedents to draft the largely bespoke certificates of formation.
PRACTICE TIP: Have clients who want to establish a nonprofit corporation put together a business plan for their nonprofit so they can understand the goals and requirements of a nonprofit corporation. The founders of a nonprofit corporation should, at a minimum, think about what they want the nonprofit to accomplish, what actions can (and cannot) be taken by individuals, and where they ultimately want the nonprofit to rest upon termination. The business plan can also take into consideration some of the financial goals, which can be tied into the nonprofit corporation’s tax exemption application with the IRS.
The certificate of formation should include the names of at least three individuals who will serve as initial directors for the corporation. The initial directors will serve until the organizational meeting is held and permanent directors can be selected. There is no limit on how many directors can serve, but three to nine is the most common range of director seats on a nonprofit corporation. The certificate of formation should also specify if the corporation will have members. As with other entities, the rest of the required language in the certificate of formation for a nonprofit corporation sets out the registered agent’s name and address, the name and address of the organizer, and the effective date of incorporation.
PRACTICE TIP: The certificate of formation can include more detailed language governing the director election process, the directors’ indemnification or exculpation, methods of voting with or without a meeting, the qualifications and residency requirements for directors, the methods for removing or replacing a director, and other language as necessary.
After the certificate of formation is filed, it is important for the nonprofit corporation (or its advisors) to draft other governing documents in preparation for the organizational meeting. These documents include bylaws, meeting minutes (or unanimous written consent by directors in lieu of a meeting), consent and resignation of the organizer, a codification of the conflicts of interest, document retention and donation policies, and other documents as the initial board deems necessary. These documents will be submitted to the IRS as part of the tax exemption application process. Once they are prepared, and soon after the certificate of formation is filed with the secretary of state, a meeting should ideally be held in person or by remote means or, alternatively, via a detailed unanimous written consent circulated to every director of the corporation.
§ 20.2Federal Tax Exemption for Nonprofit Corporations
For the purpose of this discussion, we will focus on IRS Form 1023, Application for Recognition of Exemption Under Section 501(c)(3) of the Internal Revenue Code, required for the federal tax exemption for nonprofit corporations.
PRACTICE TIP: The IRS updates and amends forms often. Make sure that you obtain the latest versions of IRS Form 1023 and the Instructions for Form 1023.
When filing the certification of formation (even when using the state of Texas forms) practitioners must consider and meet the requirements of IRS Form 1023 to obtain exemption. The certificate of formation requires a purpose, and if the entity is to be tax-exempt, that purpose must be deemed acceptable by the IRS. Acceptable purposes for IRS Form 1023 are “charitable, religious, educational, scientific, literary, testing for public safety, fostering national or international amateur sports competition, and preventing cruelty to children or animals.” Internal Revenue Serv., Dep’t. of the Treasury, Instructions for Form 1023, Application for Recognition of Exemption Under Section 501(c)(3) of the Internal Revenue Code 7 (2020).
In addition, the certificate of formation must state how the assets of the organization will be distributed upon dissolution. If using the state of Texas forms, this should be listed in the “additional language” area. The IRS approves the following language:
Upon the dissolution of this organization, assets shall be distributed for one or more exempt purposes within the meaning of section 501(c)(3) of the Internal Revenue Code, or corresponding section of any future federal tax code, or shall be distributed to the federal government, or to a state or local government, for a public purpose.
Instructions for Form 1023 8.
PRACTICE TIP: Do not deviate from the simple language provided by the IRS in the certificate of formation. In addition, use the IRS Sample Conflict of Interest Policy for the organization bylaws, which can be found in appendix A of the Instructions for Form 1023. This language is acceptable to the IRS and will not be questioned by revenue agents. Bylaws can always be amended after the application for tax exemption is accepted.
For the organization’s exempt status to be effective as of the date of the approved certificate of formation, IRS Form 1023 should be filed within twenty-seven months of the secretary of state’s approval. If the application is filed after that twenty-seven month period, however, the exemption date will be effective as of the date IRS Form 1023 is filed.
IRS Form 1023 requires a narrative description of the organization’s activities and the organization’s financial data. If the organization is new and has not conducted activities or does not have financial data, that should be noted on the application, and the answers to these questions should outline the planned activities and the anticipated revenues and expenses. The level of detail depends on whether the organization uses IRS Form 1023 or IRS Form 1023-EZ. Each question should be answered in detail but as succinctly as possible.
PRACTICE TIP: If the application is not complete or the narrative and financial data are not clear, the application will be sent to a revenue agent, which will delay the application process by several months. The trick is being clear without being overly wordy.
The IRS considers any organization applying for exempt status using IRS Form 1023 to be a private foundation unless the organization meets certain criteria, which generally amount to a determination of whether the organization is a public charity. A public charity receives a significant amount of its funds through public support. To gain this public charity status, the entity must meet both the “one-third public support test” and the “not-more-than-one-third investment income and net unrelated business income test.” Instructions for Form 1023 14.
Every organization that qualifies for tax exemption as an organization described in section 501(c)(3) is a private foundation unless it falls into one of the categories specifically excluded from the definition of that term (referred to in section 509(a)). In addition, certain nonexempt charitable trusts are also treated as private foundations. Organizations that fall into the excluded categories are institutions such as hospitals or universities and those that generally have broad public support or actively function in a supporting relationship to such organizations.
Internal Revenue Serv., Dep’t. of Treasury, Private Foundations, IRS (Dec. 20, 2019), www.irs.gov/charities-non-profits/charitable-organizations/private-foundations.
PRACTICE TIP: It is important to understand where an organization plans to obtain its funding. If you are unsure if the organization truly qualifies for public charity status or private foundation status, let the IRS choose. This will prevent the application from being held up by a revenue agent.
§ 20.3Governance of Nonprofit Corporations
A nonprofit corporation’s certificate of formation should clearly state who is authorized to manage the organization and the specific acts they are authorized to perform.
A nonprofit corporation may be managed by members if that is plainly set out in the certificate of formation. See Tex. Bus. Orgs. Code § 22.202(a). It is important, however, to consider the practicality of having members manage corporate affairs, given, for example, frequent changes in membership status. If the organization has various levels of membership, the certificate of formation should be clear on which levels have voting privileges.
§ 20.3:2Management by Board of Directors
Absent a designation in the certificate of formation, management of a nonprofit corporation will be vested in the board of directors. Tex. Bus. Orgs. Code § 22.202(b). The board must consist of at least three directors. Tex. Bus. Orgs. Code § 22.204. Any organization that operates with fewer than three directors is not in compliance with the TBOC. Maintaining an odd number of directors is best to establish a clear majority when voting.
It is important that any organization has a process to elect or appoint the board of directors. These acts should be completed during the annual meeting. If the board is large (seven or more directors), using alternate term years is preferable. For example, three board positions may be up for election or appointment during even-numbered years and four during odd-numbered years. This ensures the continuity of the board.
Directors must perform their duties “in good faith, with ordinary care, and in a manner the director reasonably believes to be in the best interest of the corporation.” Tex. Bus. Orgs. Code § 22.221(a).
Good Faith: Directors must act honestly and trustworthily in their duties and obligations. The directors should not attempt to take advantage of the corporation and should avoid self-dealing.
Care: Directors must be vigilant when conducting the affairs of the organization. This means that they have to monitor the finances of the organization, attend regular meetings, evaluate the records of staff, and operate in accordance with the organization’s bylaws.
Best Interests of Corporation: Directors must act reasonably based on the objective facts available to them at the time a decision is made. Objective facts include what the directors know and what they should have known. When acting in the best interest of the corporation, directors should consider both the short-term and long-term interests of the organization.
Many organizations have nonvoting advisory boards. This is acceptable if the bylaws clearly state that an advisory board is allowed. If so, the bylaws must also include the advisory board’s roles and responsibilities. The advisory board should have a clear appointment or designation process that is consistently followed and approved by the board of directors.
PRACTICE TIP: Many nonprofit organizations are started by people who want to do good, but who are ill-equipped to handle the responsibilities of running a public organization. It is important to express to your clients the importance of documenting and maintaining proper board responsibilities. Many founding organizers want to control their organizations. This is not possible through charitable nonprofit organizations that seek tax exemption. Making the distinction between what is allowed in a for-profit organization versus a nonprofit organization can help keep the directors on track.
A board resolution is used when an action of the board requires a formal record of an issue. It differs from meeting minutes in that meeting minutes describe discussions and actions (such as votes) taken during a meeting. Board resolutions are legally binding actions or decisions by the board. Board resolutions will sometimes be incorporated into the minutes; however, significant decisions that need to be highlighted may be in a separate or stand-alone resolution.
PRACTICE TIP: Most nonprofit corporations loosely follow Robert’s Rules of Order and do not formally adhere to motions and resolutions. Therefore, meeting minutes are usually not sufficient to highlight or acknowledge significant decisions of the board. When it comes to major decisions, as discussed below, a separate written resolution should be used to document the process and final decision.
The TBOC distinguishes between nonprofit corporations that have members with voting rights and those that are governed by a board of directors. When a nonprofit corporation has members with voting rights, specific attention must be paid to voting procedures and documentation. Board resolutions are required under the following circumstances:
•amendment to the certificate of formation (Tex. Bus. Orgs. Code § 22.105)
•authorization of a restated certificate of formation (Tex. Bus. Orgs. Code § 22.109)
•adoption of a plan of merger (Tex. Bus. Orgs. Code § 22.251)
•sale of substantially all assets (Tex. Bus. Orgs. Code § 22.252)
•approval of a conversion (Tex. Bus. Orgs. Code § 22.256)
•approval of an exchange (Tex. Bus. Orgs. Code § 22.257)
PRACTICE TIP: Although the TBOC requires resolutions for only nonprofit corporations with member voting rights, it is strongly recommended that resolutions be written for nonmember organizations as well.
In addition, whether the organization has members with voting rights or not, a board resolution is required in the following cases:
•creation of a committee exercising the authority of the board (Tex. Bus. Orgs. Code § 22.218)
•creation of a board-only committee (Tex. Bus. Orgs. Code § 22.219)
•sale of real property (Tex. Bus. Orgs. Code § 22.255)
In addition to the TBOC-required resolutions (which are limited), resolutions may be required or necessary many other times for documentation purposes.
Banking Resolutions. Banking resolutions are used when authorizing who can access the account or make financial decisions for the organization. Banks often require resolutions for changes in board or executive staff that are signers on the bank account. Board members change often, and therefore when someone is newly elected to a position that may access the bank account, a resolution will be required to make the change through the banking institution. See form 20-2 in this chapter for a sample banking resolution.
New Executive Director. The board should use a resolution to document hiring an executive director (ED) and approving compensation, to allow for transparency of the hiring process and vote to onboard the new ED. This is especially important if the ED is an official or unofficial member of the board. See form 20-3 in this chapter for a sample resolution electing a director.
Conflicts of Interest. While the TBOC allows for contracts between a nonprofit corporation and its board, officers, or members, such an act is a conflict of interest (see section 20.3:4 below). It is imperative, therefore, to document consideration of such a contract in the meeting minutes and the final decision through a resolution.
PRACTICE TIP: When entering into an agreement between a board member, officer, member, or volunteer of a nonprofit corporation, the board should obtain three to five bids or proposals from third parties to provide the same or similar services to determine if the contract is reasonable and in the best interest of the nonprofit corporation. This bidding or proposal process should be noted in the resolution approving the contract with the contracting party.
A resolution should always outline the problem (if there is one), the governing document(s) that the resolution complies with, and the date, time, and place of the meeting at which the resolution was approved.
The resolution should be signed by the secretary of the nonprofit corporation. The minutes should notate the actual vote.
§ 20.3:4Conflict-of-Interest Policy
A conflict-of-interest policy is a set of guidelines and procedures designed to identify and address situations where the board of directors, officers, staff, or volunteers may have competing interests that could compromise the organization’s integrity or mission. Because nonprofit organizations often rely on the public’s trust and support, a conflict-of-interest policy is important to maintain transparency, accountability, and public confidence.
Texas does not require a conflict-of-interest policy and does not prevent directors, officers, or members from doing business with the corporation or voting on contracts they may have a financial interest in. However, Tex. Bus. Orgs. Code § 22.230 provides guidance regarding when contracts between the nonprofit corporation and a director, officer, or member or an affiliate or associate of a director, officer, or member are enforceable.
Additionally, the IRS (and many large grant funders) frown upon directors, officers, staff, or volunteers doing business with the corporation unless there is a policy that controls when, where, and how it is done.
Apart from any appearance of impropriety, organizations will lose their tax-exempt status unless they operate in a manner consistent with their charitable purposes. Serving private interests more than insubstantially is inconsistent with accomplishing charitable purposes. For example, paying an individual who is in a position of substantial authority excessive compensation serves a private interest. Providing facilities, goods or services to an individual who is in a position of substantial authority also serves a private interest unless the benefits are part of a reasonable compensation arrangement or they are available to the public on equal terms and conditions.
United States Internal Revenue Service, Form 1023: Purpose of Conflict of Interest Policy (2023), www.irs.gov/charities-non-profits/form-1023-purpose-of-conflict-of-interest-policy.
The IRS does not require a conflict-of-interest policy but strongly recommends that a tax-exempt organization have one. During the process of filing for tax exemption, IRS Form 1023 inquires if there is a conflict-of-interest policy in place. If one is not, the form will ask a series of questions to determine if other policies and procedures protect against conflicts of interest. Without such policies and procedures, the tax exemption application may not be approved.
PRACTICE TIP: Use the IRS Sample Conflict of Interest Policy. More mature organizations may want to include additional policies and procedures that build on the IRS sample policies. It is recommended to include the IRS sample policy in the corporation bylaws. The IRS Sample Conflict of Interest Policy is found in the Instructions for Form 1023. See United States Internal Revenue Service, Instructions for Form 1023 (01/2020), www.irs.gov/instructions/i1023.
As an example, if a nonprofit board member also owns a business that could provide services to the nonprofit, the policy would provide a guideline to ensure such transactions are fair, reasonable, and in the best interest of the organization, thus protecting its tax-exempt status.
See article III, section 3, of the IRS sample policy:
3.Procedures for Addressing the Conflict of Interest
a. An interested person may make a presentation at the governing board or committee meeting, but after the presentation, he/she shall leave the meeting during the discussion of, and the vote on, the transaction or arrangement involving the possible conflict of interest.
b. The chairperson of the governing board or committee shall, if appropriate, appoint a disinterested person or committee to investigate alternatives to the proposed transaction or arrangement.
c. After exercising due diligence, the governing board or committee shall determine whether the Organization can obtain, with reasonable efforts, a more advantageous transaction or arrangement from a person or entity that would not give rise to a conflict of interest.
d. If a more advantageous transaction or arrangement isn’t reasonably possible under circumstances not producing a conflict of interest, the governing board or committee shall determine by a majority vote of the disinterested directors whether the transaction or arrangement is in the Organization best interest, for its own benefit, and whether it is fair and reasonable. In conformity with the above determination, it shall make its decision as to whether to enter into the transaction or arrangement.
United States Internal Revenue Service, Instructions for Form 1023 (01/2020), art. III(3), www.irs.gov/instructions/i1023.
As another example, if a nonprofit executive’s spouse runs a consulting firm and the nonprofit needs consulting services, the conflict-of-interest policy would help guide the process. The executive would disclose the relationship, and potentially recuse themselves from the decision-making process, demonstrating transparency and building trust.
See article III, section 1, of the IRS sample policy:
1.Duty to Disclose. In connection with any actual or possible conflict of interest, an interested person must disclose the existence of the financial interest and be given the opportunity to disclose all material facts to the directors and members of committees with governing board delegated powers considering the proposed transaction or arrangement.
United States Internal Revenue Service, Instructions for Form 1023 (01/2020), art. III(1), www.irs.gov/instructions/i1023.
As a third example, if a nonprofit board member stands to gain personally from a board decision, having the board member disclose the conflict and recuse themselves from the decision-making process can prevent allegations of impropriety and potential legal action.
See article V of the IRS sample policy:
Compensation
a.A voting member of the governing board who receives compensation, directly or indirectly, from the Organization for services is precluded from voting on matters pertaining to that member’s compensation.
b.A voting member of any committee whose jurisdiction includes compensation matters and who receives compensation, directly or indirectly, from the Organization for services is precluded from voting on matters pertaining to that member’s compensation.
c.No voting member of the governing board or any committee whose jurisdiction includes compensation matters and who receives compensation, directly or indirectly, from the Organization, either individually or collectively, is prohibited from providing information to any committee regarding compensation.
United States Internal Revenue Service, Instructions for Form 1023 (01/2020), art. V, www.irs.gov/instructions/i1023.
PRACTICE TIP: Encourage organizations to provide annual training on conflicts of interest and self-dealing. Many organizations, especially small nonprofits that are board-led, frequently violate conflict-of-interest policies or engage in self-dealing because they lack knowledge regarding these matters.
§ 20.4Annual Meetings and Recordkeeping for Nonprofit Corporations
Nonprofit organizations must hold an initial meeting to adopt bylaws and to elect officers. Tex. Bus. Orgs. Code § 22.104(a). It is recommended that a business attorney attend this meeting to explain organizational documents to the board of directors. Meeting minutes should document the election process and the vote.
PRACTICE TIP: Meeting minutes are important to any organization. The minutes should be detailed enough to assist the board in deciding significant issues.
In addition to documenting adopting bylaws and electing officers, the initial meeting minutes should reflect an authorization to open a bank account and to file a tax exemption application (if applicable) and should indicate an acknowledgment of any members and of any other initial acts by the board of directors.
If the organization is member-managed, a separate meeting should be held to allow the members to vote in accordance with the bylaws.
The organization should establish a specific date and time each year that it will hold an annual meeting of the board of directors and, if applicable, members. If the organization has regularly set meetings outside of the annual meeting, the board and any members should receive timely notice providing the time and place of the meetings.
PRACTICE TIP: Meeting minutes can be discovered as legal evidence. Minutes should detail the discussions and resulting votes from any action, should be kept in the regular course of business, and should be stored accordingly.
Members have the right to inspect the books and records of a nonprofit corporation. Tex. Bus. Orgs. Code § 22.351. If a member issues a written demand for the books and records, the organization must comply and provide a time and place for inspection.
The organization must maintain current and accurate financial records. Tex. Bus. Orgs. Code § 22.352(a). The board of directors must ensure that annual reports are produced each year. Tex. Bus. Orgs. Code § 22.352(b). This financial report is public information. See Tex. Bus. Orgs. Code § 22.353(b). Failure to maintain financial records, prepare an annual report, or make the report available to the public is a class B misdemeanor. Tex. Bus. Orgs. Code § 22.354. Exemptions to this requirement are listed in TBOC section 22.355.
PRACTICE TIP: Each organization should have a written document management policy that states the length of time and manner in which documents should be held and when and how they should be destroyed. This policy should be provided to staff and volunteers and should become a regular business practice of the organization.
§ 20.5Periodic Reports for Nonprofit Corporations
Domestic and foreign nonprofit corporations are subject to periodic reporting requirements with the secretary of state.
A nonprofit corporation is required by TBOC section 22.357 to file a periodic report that lists the names and addresses of its current registered agent and office and its current officers and directors. The Texas secretary of state is authorized to require a nonprofit corporation to file the report (SOS Form 802, www.sos.state.tx.us/corp/forms/802_boc.pdf) not more than once every four years. See Tex. Bus. Orgs. Code § 22.357.
The report is due no later than the thirtieth day after the date the secretary of state sends notice to the corporation that the report is due. See Tex. Bus. Orgs. Code § 22.359. The secretary of state sends all notices relating to the filing of the periodic report, including any notice of forfeiture or delinquency, to the designated registered agent at the registered office address on file. See Tex. Bus. Orgs. Code § 22.358.
The notice sent by the secretary includes a preprinted periodic report form that includes the current information of record.
PRACTICE TIP: There is no “anniversary date” for the filing of a nonprofit periodic report. A nonprofit corporation may avoid the consequences of noncompliance, however, by voluntarily submitting a periodic report to the secretary of state on a routine basis on an “anniversary date” of its own choosing. Periodic reports also may be filed electronically through the secretary of state’s online access system, SOSDirect.
Certain restrictions and limitations apply to mergers involving Texas nonprofit corporations.
Pursuant to TBOC section 10.010(a), a nonprofit corporation may not merge into another entity if the nonprofit corporation would lose or impair its charitable status because of the merger. Tex. Bus. Orgs. Code § 10.010(a). Note, however, that the secretary of state does not determine whether a proposed merger will affect a nonprofit corporation’s charitable status.
One or more domestic or foreign for-profit entities or non-code organizations may merge into one or more domestic nonprofit corporations if the nonprofit corporations continue as the surviving entity or entities. Tex. Bus. Orgs. Code § 10.010(b). A nonprofit corporation may merge with a foreign for-profit entity, but only if the nonprofit corporation continues as the surviving entity. Tex. Bus. Orgs. Code § 10.010(c). One or more nonprofit corporations and non-code organizations may merge into one or more foreign nonprofit entities that continue as the surviving entity or entities. Tex. Bus. Orgs. Code § 10.010(d).
Although an unincorporated nonprofit association is a TBOC entity, it is not authorized to engage in a statutory merger under chapter 10 of the code. Section 252.017 specifically provides that the only provisions of the TBOC that apply to an unincorporated nonprofit association are chapters 1 and 4 and, if a nonprofit association has designated an agent for service of process, the provisions of subchapter E of chapter 5. Pursuant to section 1.106(c), this specific provision of chapter 252 would supersede the provisions of chapter 10. See Tex. Bus. Orgs. Code § 1.106(c).
The fee for filing a merger transaction of a nonprofit corporation with a for-profit entity is $300. The fee for filing a merger transaction where the only parties to the merger are nonprofit corporations is $50.
§ 20.7Conversion of Nonprofit Corporations
§ 20.7:1Conversion of Nonprofit into For-Profit Entity Prohibited
TBOC section 10.108 specifically prohibits the conversion of a nonprofit corporation to a for-profit entity. See Tex. Bus. Orgs. Code § 10.108.
§ 20.7:2Conversion of Nonprofit Corporations into Other Entities
While section 10.108 prohibits a nonprofit corporation from converting into a for-profit entity, the secretary of state will accept a certificate of conversion that converts a domestic nonprofit corporation to a nonprofit limited liability company, a nonprofit corporation created under another Texas statute, or a foreign nonprofit corporation.
§ 20.8Failure to File Periodic Report—Chapter 22 TBOC Involuntary Terminations
§ 20.8:1Effect of Failure to File Periodic Report
Failure to file the nonprofit periodic report when due results in the forfeiture of the corporation’s right to conduct its affairs in Texas. See Tex. Bus. Orgs. Code § 22.360(a). Notice of forfeiture is mailed to the corporation’s registered agent at the registered office address. See Tex. Bus. Orgs. Code § 22.361.
Forfeiture of the corporation’s right to conduct its affairs does not impair the validity of a contract or act of the corporation or prevent the corporation from defending an action, suit, or proceeding in a court of this state, but the corporation may not maintain an action, suit, or proceeding in a court of this state. See Tex. Bus. Orgs. Code § 22.362(c).
A Texas nonprofit corporation that fails to file the delinquent periodic report and revive its right to conduct business within 120 days of the mailing of the notice of forfeiture is involuntarily terminated by the secretary of state. See Tex. Bus. Orgs. Code §§ 22.363, 22.364.
A nonprofit corporation that has involuntarily terminated its existence for its failure to file a periodic report is reinstated by following the specific reinstatement procedures set forth in TBOC section 22.365 and not the procedures established under section 11.253. See Tex. Bus. Orgs. Code § 22.365.
A nonprofit corporation involuntarily terminated under TBOC section 22.364 would file the delinquent report together with the maximum filing fee of $25. The corporation would not submit a certificate of reinstatement.
TBOC section 22.365 does not set forth a time frame within which the delinquent report must be filed and the corporation reinstated.
Section 22.365(a) requires the secretary of state to determine whether the corporation has paid all fees, taxes, penalties, and interest due and accruing before the termination and an amount equal to the total taxes from the date of termination to the date of reinstatement that would have been payable if the corporation had not been terminated. See Tex. Bus. Orgs. Code § 22.365(a). If the nonprofit corporation is not tax-exempt, a tax clearance letter issued by the comptroller of public accounts stating that the entity is in good standing for purposes of reinstatement fulfills this requirement. The tax clearance letter must accompany the delinquent report and must be valid through the date of filing of the report.
§ 20.9Dissolution of Nonprofit Corporations
TBOC chapters 11 and 22 state the procedures for winding up and terminating a nonprofit corporation. Section 22.302 of the TBOC provides details specific to nonprofits managed by members, managed by boards of directors with voting membership, managed by boards of directors with no members, and managed by memberships without voting rights. The appropriate notice provisions must be followed in each case. TBOC section 22.164 defines dissolution as a fundamental action and subsequently requires appropriate approvals to dissolve or terminate a nonprofit corporation.
In addition to following the procedural formalities, the nonprofit corporation must create a plan of distribution in accordance with TBOC section 22.304 and with the corporation’s dissolution clauses, whether in its certificate of formation, its bylaws, or both. All liabilities and obligations must be paid, satisfied, and discharged in accordance with TBOC section 11.053. Then any property held on a condition requiring return, transfer, or conveyance because of the termination of the corporation must be returned. The remainder of the property may then be distributed to other organizations that are exempt under section 501(c)(3) of the Internal Revenue Code (IRC) or that are described in IRC section 170(c)(1) or (c)(2). Lastly, a district court will distribute any remaining assets to organizations exempt under IRC section 501(c)(3) or described in section 170(1) or (2).
PRACTICE TIP: The certificate of formation must include how the assets of the organization will be distributed upon dissolution in order to obtain the federal tax exemption.
§ 20.9:1Filing Certificate of Termination with Secretary of State
When winding up activities are complete, the organization must file a certificate of termination (SOS Form 652, www.sos.state.tx.us/corp/forms/652_boc.pdf) with the secretary of state. The certificate of termination must be signed by an officer of the nonprofit corporation. The existence of the nonprofit ends upon filing the certificate of termination, unless a later date is given or the certificate states that it is effective when a stated event or fact takes place (the termination must be effective within ninety days of the date of signing).
Organizations recognized under IRC section 501(c)(3) that are required to file annual information returns must file the appropriate IRS Form 990, marked as a final return, to inform the IRS about its termination. The final IRS Form 990 must be filed within four months and fifteen days after the effective date of the nonprofit corporation’s termination. The corporation should then complete an IRS Form 990 or 990-EZ schedule N (Liquidation, Termination, Dissolution, or Significant Disposition of Assets) with the applicable information.
For additional content relevant to the topic of this chapter, see the following:
Application for Registration for a Nonprofit Corporation or Cooperative Association (SOS Form 302), www.sos.state.tx.us/corp/forms/302_boc.pdf
Certificate of Formation—Nonprofit Corporation (SOS Form 202), www.sos.state.tx.us/corp/forms/202_boc.pdf
Certificate of Termination of a Domestic Nonprofit Corporation or Cooperative Association (SOS Form 652), www.sos.state.tx.us/corp/forms/652_boc.pdf
Periodic Report of a Nonprofit Corporation (SOS Form 802), www.sos.state.tx.us/corp/forms/802_boc.pdf