Washington Nonprofit Corporations
While a variety of organizational structures exist for nonprofit organizations in Washington(business leagues and homeowners associations are often formed under Chapter 24.06 RCW, bishops, overseers or presider elders of a church may incorporate under Chapter 24.12 RCW, fraternal societies incorporate under RCW 24.20, employee cooperatives may incorporate under Chapter 23.78 RCW, cooperative associations under Chapter 23.86 RCW, granges under Chapter 24.76, mutual insurance companies under Chapter 48.09 RCW and charitable trusts under RCW 11.110 et seq.) the vast majority are formed as nonprofit corporations. The Washington Nonprofit Corporation Act (the “Act”) governs the formation, operation and dissolution of nonprofit corporations in Washington. A nonprofit corporation in Washington is managed by its board of directors and operated by its officers and employees. Instead of shareholders, a nonprofit corporation may, but is not required to, have members. Nonprofit corporations, of course, are specifically organized to not earn profits. No part of the income or surplus of a Washington nonprofit corporation may be distributed to its members, directors or officers; however, reasonable compensation may be paid for services rendered. Nonprofit corporations are prohibited from issuing shares of stock.
A nonprofit corporation has an existence of its own, independent of the terms of office or employment of members, directors or officers. It can sue or be sued in its own name, lend money (except to officers and directors) and own real estate and personal property in its own name.
Advantages of Incorporation: pros and cons of nonprofit vs for-profit
The principal advantage of incorporation is that it protects the shareholders or members from personal liability for the obligations and liabilities of the corporation, including unlawful actions of officers, directors and staff acting on its behalf. In addition, incorporation establishes continuity; corporations are subject to a body of statutes that provide very specific guidance as to their formation and operation; and incorporation brings stature to the organization and implies stability.
Where profit is not a goal and the enterprise can be funded without the need for access to capital markets, the nonprofit corporation is the preferred vehicle for pursuing social objectives. Although nonprofit corporations are not prohibited from engaging in commercial activities, the directors of a nonprofit are duty-bound to devote primary attention to the promotion of the social mission of the corporation rather than the production of net income.
On the other hand, if access to capital markets is needed, a for-profit corporation (or limited liability company, discussed here) is likely to be the preferred option because nonprofit corporations cannot issue capital stock. The directors of a for- profit corporation, however, owe strict duties to the shareholders to maximize profits and value. Therefore, unless the directors and managers can tie the social mission of their for-profit corporation directly to its business purpose, they can be sued for breach of their duties to shareholders and for misuse of corporate assets if they focus too much on the social mission and forego profits. This problem can be avoided where all shareholders agree to pursue a social mission or devote a percentage of revenues to charitable causes but such agreements may be temporary because a change in control—or a drop in earnings—can lead to amendment or abrogation of shareholder agreements.
A nonprofit corporation attains its separate legal status through the filing and approval by the Washington Secretary of State of its articles of incorporation. This document is in essence a contract between the state and the nonprofit corporation in which Washington grants individual legal status to the corporation in exchange for the corporation’s commitment to follow its rules.
The Act requires incorporators to include the following information in the articles of incorporation:
The organization’s name may not include or end with “incorporated,” “corporation,” “company,”, “limited partnership,” “Ltd” or any other corporate designation, nor may it be the same or deceptively similar to an existing or reserved corporate, limited partnership or limited liability company name. The name must not describe the purpose of the organization in a misleading manner. Incorporators should inquire with the Corporations Division of the Secretary of State to determine if a name is available in Washington. You may reserve a name with the Corporations Division for up to 180 days before deciding to use it.
Term of Existence
The articles of incorporation must state the term of existence of the corporation, even if it is intended to be perpetual.
The articles of incorporation must include a description of the corporation’s purpose. The Act states that a nonprofit corporation may be organized for any lawful purpose, including but not limited to charitable, benevolent, eleemosynary, educational, civic, patriotic, political, religious, social, fraternal, literary, cultural, athletic, scientific, agricultural, horticultural, animal husbandry, and professional, commercial, industrial or trade association. If the incorporator intends to seek tax-exempt status under federal tax law, the description of purpose should be consistent with federal requirements.
The name and geographic address of the corporation’s registered agent for service of process must be stated in the articles of incorporation. A post office box is acceptable only if the geographic address is also provided.
The articles of incorporation must provide for the number, name and address of the initial director(s). The minimum number of directors is one; there is no maximum number. Directors must be individuals, not corporations or other entities. The articles of incorporation may provide for a range in size (for example, no fewer than three and no more than seven directors).
The articles of incorporation must set forth the name and address of incorporator(s). The incorporator also signs the articles of incorporation. The incorporator may be an individual (at least eighteen years of age) or an entity. The incorporator may be personally responsible for any pre-incorporation expenses or liabilities. As a result, it is important to keep accurate records of any pre-incorporation activities and have the initial board of directors ratify (or approve) all pre-incorporation activities.
In the event a tax exempt nonprofit corporation is dissolved, assets must be distributed in accordance with federal tax law (i.e., to another 501(c)(3) organization). The articles of incorporation must identify the name and address of the person or incorporation to whom assets will be distributed in the event of dissolution.
Though not required, it is good practice to include some additional provisions, as follows:
- Limitation on Director Liability. It is advisable to include a provision that eliminates the personal liability of directors of the nonprofit corporation for monetary damages for their conduct as a director (except for acts or omissions that involve intentional misconduct, a knowing violation of law, or for a transaction from which the director will personally receive a benefit in money, property or services to which the director is not legally entitled).
- Indemnification of Directors and Officers. The articles of incorporation may provide for indemnification of the nonprofit corporation’s current and past directors and officers, pursuant to which the nonprofit corporation is obligated to pay the expenses, liabilities and losses incurred by a director or officer in connection with any claim arising from their acts or omissions as a director or officer of the corporation.
- Tax-Exempt Purpose. In order to qualify for federal tax-exempt status, the nonprofit corporation must satisfy certain additional requirements in its articles of incorporation. Among them, it must include a statement prohibiting the distribution of net earnings to members, directors, officers or any private individual. The articles of incorporation should also address the prohibition of non-charitable activities and the limitations on political action and lobbying. Please refer to the attached form of articles of incorporation for sample language, and please be advised that the form provided by the Washington Secretary of State’s office does not include these important provisions.
There are certain corporate forms available on the Washington Secretary of State’s website, including a standard form of articles of incorporation. However, as stated above, incorporators should be sure to add the provisions that are necessary to qualify the corporation as tax exempt under federal tax law, as the forms made available by the Secretary of State do not include this language.
Management and Control
The board of directors is the governing body of a nonprofit corporation. In Washington, the board of directors is sometimes referred to as the “board of trustees.” Once the nonprofit corporation has been established, the initial board of directors should meet (in person/by consent) to ratify the acts in connection with the initial formation of the corporation and adopt bylaws which set forth the rules and procedures governing the decision-making process of the board of directors and the general operation and management of the corporation consistent with the applicable statutes of Washington and the articles of incorporation.
Typically, the bylaws of a nonprofit corporation contain provisions governing member, director and officer qualifications, powers, and duties; voting; filling of vacancies; meetings; property holding and transfer; indemnification of directors and officers; committees; bank accounts; fiscal year audits and financial reports; conflicts of interest; and amendment and dissolution procedures. Bylaws are not filed with the Secretary of State’s office.
The nonprofit corporation may have members or may elect to be a “nonmembership” corporation. The decision depends on the fundamental purpose of the organization and the manner in which it is expected to be managed. Unless otherwise provided in the nonprofit corporation’s governing documents, members have certain voting rights. Membership can be useful when a nonprofit corporation intends to raise funds or when the activities of the nonprofit corporation necessitate group participation. On the other hand, membership also carries with it an administrative burden: seeking votes from a large group of members can hinder the organization’s ability to take quick action.
For sample bylaws, please see the attached forms for nonprofit corporations with members and without members.
Liability of Members, Directors and Officers
Directors and officers may act on behalf of the nonprofit corporation within the scope of authority granted by the nonprofit corporation’s governing documents and the Act. Directors and officers have a duty to ensure that the corporation acts within the scope of the purpose described in its articles of incorporation. Directors have a fiduciary duty of care; they must perform their duties in good faith, in a manner they believe to be in the best interests of the nonprofit corporation, and with such care as an ordinarily prudent person would use in similar situations. While the Act does not expressly address conflicts of interest, it is considered “best practice” to adopt a formal conflict of interest policy. Directors may be sued for breach of a duty owed to the nonprofit corporation. Depending on the circumstances, directors and officers may also be held personally liable for certain employment practices, environmental liabilities and tax obligations. Other specific sources of potential liability are as follows:
- The Act prohibits nonprofit corporations from making loans to officers or directors. Any director who votes for or assents to such a loan, and any officer who participates in making such a loan, will be held jointly and severally liable to the corporation for the amount of the loan until such loan is paid in full. .
- The Secretary of State may submit a request to any officers or directors of a nonprofit corporation for information to determine whether the corporation is in compliance with law. Upon receiving such a request, the officer or director must respond in writing within thirty days. Failure to do so, or responding in a way that he or she knows is materially false, constitutes a misdemeanor offense.
- The personal liability of directors may be eliminated or limited pursuant to the articles of incorporation. Just as a for-profit corporation may indemnify its officers and directors, so may a nonprofit corporation. A corporation may indemnify a director who is defending a lawsuit if (i) the director acted in good faith; (ii) if the director’s conduct stemmed from his or her official capacity with the corporation, the director reasonably believed that the director’s conduct was in the corporation’s best interests (or, in all other cases, that the director’s conduct was not opposed to the corporation’s best interests); and (iii) in the case of a criminal proceeding, the director had no reasonable cause to believe that his or her conduct was unlawful. Nonprofit corporations may also purchase director’s and officer’s liability insurance to cover certain claims.
Pursuant to RCW 24.03.185, any two or more nonprofit corporations may merge into another nonprofit corporation. In order to do so, each of the merging corporations must adopt a plan of merger that includes (i) the names of the corporations proposing to merge; (ii) the designation of one of them as the “surviving corporation”; (iii) the terms and conditions of the proposed merger; (iv) a statement of any changes to the articles of incorporation of the surviving corporation; and (v) any other provisions that are deemed necessary or advisable.
A nonprofit corporation may also consolidate with another nonprofit corporation. The procedure is similar – the corporations each adopt a plan of consolidation which sets forth each of the requirements described above. The distinction between a merger and a consolidation is important from an administrative standpoint: in a merger, the two corporations join together and one of them survives the merger. In a consolidation, the two corporations form a new corporation, which requires a new application for tax exempt status.
The parties must also prepare articles of merger (or articles of consolidation), which are filed together with the plan of merger (or plan of consolidation, as the case may be) with the Secretary of State’s office together with the appropriate filing fees. In the event one of the parties to a merger or consolidation is a nonprofit corporation formed in a jurisdiction other than Washington, that party must follow the procedures required in the state of its incorporation.
Pursuant to the Act, a nonprofit corporation may be dissolved using a number of different methods: (i) it may be dissolved voluntarily by its directors and members; (ii) it may be administratively dissolved by the Secretary of State for failure to comply with filing requirements; or (iii) it may be dissolved by judicial decree, in the event the nonprofit corporation’s articles of incorporation were procured through fraud or the nonprofit corporation has exceeded or abused its authority. If the members of a nonprofit corporation are entitled to vote on dissolution, they are provided notice and the opportunity to vote, and the dissolution will be approved if at least two-thirds of the members entitled to vote approve such action.
Recordkeeping, State Reports and State Taxes
Pursuant to RCW 24.03.135, each nonprofit corporation must maintain the following records: (i) current articles of incorporation and bylaws; (ii) a list of all members, including names, addresses and classes of membership, if any; (iii) correct and adequate statements of accounts and finances; (iv) a list of officers’ and directors’ names and addresses; and (v) minutes of the proceedings of the members, if any, the board of directors, and any minutes which may be maintained by committees of the board of directors. The records must be made available for inspection by any member of more than three months standing or a representative of more than five percent of the membership.
All nonprofit corporations in Washington are required to file an annual report with the Secretary of State. The annual report filing fee is currently $10 for nonprofit corporations. Nonprofit corporations must also submit a master business application with the Washington State Department of Licensing. The master business application requires a filing fee of $15. Depending on its location and activities, the nonprofit corporation should also determine whether there are local business licensing requirements and state and local solicitation requirements.
Nonprofit corporations in Washington are presumed to be taxable to the same extent as for-profit corporations. Therefore, unless the nonprofit corporation qualifies for a statutory exemption or deduction, it is liable for business taxes, retail sales taxes, use taxes and real and personal property taxes (as required at the state and local level). The nonprofit corporation has the burden of proof of establishing that it qualifies for any available exemption or deduction. Nonprofit corporations should consult with a tax advisor to determine whether a specific exemption or deduction applies to it based on its activities in Washington.
State Business and Occupation Tax (the “B&O tax”)
Washington requires B&O taxes to be calculated based on the gross receipts of every person engaged in business activities in Washington.Exemptions are available for nonprofit corporations with gross annual receipts of $12,000 or less provided that the corporation is not required to pay any other state tax (such as the sales or use tax). A nonprofit corporation with gross annual receipts of $28,000 or less may qualify for the small business tax credit, which may be used to offset all or a portion of the B&O tax. Exemptions and deductions are also available based on the activities of the nonprofit corporation; for example, there are exemptions and deductions available for artistic and cultural organizations, blood, bone and tissue banks, adult family homes, comprehensive cancer centers, organ procurement organizations, and others. Exemptions are also available for certain fundraising activities.
Local B&O Tax
Cities in Washington may also impose a separate B&O tax on the activities of a nonprofit corporation. Cities have discretion to define their own B&O tax requirements, so nonprofit corporations are strongly urged to review local tax codes in the cities in which they operate and seek input from a tax advisor regarding the availability of exemptions, deductions and credits.
Retail Sales Tax
In Washington, retail sales tax applies to sales of any article of tangible personal property to consumers as well as certain services performed for consumers. There are exemptions for sales to the Red Cross, sales of food products for human consumption, sales to artistic or cultural organizations of certain objects used for exhibition or presentation, certain fundraising activities, and others.
Washington imposes a use tax on the user of any article of tangible personal property or certain services acquired by purchase or gift where the user or donor has not paid the retail sales tax.
Real Estate Excise Tax
A transfer tax is imposed on the sale of real property. There are a number of exemptions to the real estate excise tax, including gifts of real property and transfers of real property that involve only a change in the identity or form of ownership.
Some nonprofit corporations may qualify for an exemption from the payment of real property taxes. Exemptions are based on specific types of activities conducted on the real property. For example, public property, cemeteries, churches, camp facilities, nonprofit day care centers, libraries or orphanages, among others, may qualify for an exemption.
More information may be obtained by contacting the Washington State Department of Revenue at 1-800-647-7706 or online at http://dor.wa.gov.
Nearly every type of activity by a nonprofit corporation can become the target of some kind of a claim by a firm or an individual that alleges damage or injury by the corporation or individuals responsible for it (i.e., directors, officers or employees). Even if the claim is without merit, the costs of defending against the claim can be very substantial.
To encourage qualified individuals to accept positions as directors and and officers, many nonprofit corporations purchase insurance to cover director and officer (D&O) liability. In addition, most responsible nonprofit corporations purchase a basic comprehensive general liability policy that covers liability for accidents in the corporation’s offices, at sponsored meetings and the like.
Liability insurance for nonprofit corporations is often a very complicated matter. Consultation with an experienced and knowledgeable agent or consultant is essential in order to obtain the right coverage at the lowest premium.
- Oleck and Stewart, Nonprofit Corporations, Organizations & Associations (Prentice-Hall, 1994, Cum. Supp. 2002)
- Jacobs, Jerald A., Association Law Handbook (ASAE & The Center for Association Leadership 4th ed., 2007)
- Nonprofit Governance and Management (American Bar Association and American Society of Corporate Secretaries, 2002)
- Guide to Nonprofit Corporate Governance in the Wake of Sarbanes-Oxley (American Bar Association Section of Business Law, 2005)
- Guidebook for Directors of Nonprofit Corporations (American Bar Association Section of Business Law 2d ed., 2002)
- Takagi, Gene. “Nonprofit Bylaws - Common Issues” Nonprofit Law Blog http://www.nonprofitlawblog.com/home/2009/09/nonprofit-bylaws-common-issues.html
- Washington Nonprofit Handbook: How to Form and Maintain a Nonprofit Corporation in Washington State (Washington Attorneys Assisting Community Organizations and the King County Bar Association Young Lawyers Division, 2009)