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Nonprofit Education

Reinstatement Series 6: How To Dissolve A Nonprofit Organization With The IRS

When starting a nonprofit, we hope the organization will last forever and provide community benefits that outlive us. The last thing a newly formed Board of Directors wants to consider is closing the organization. However, dissolution is a natural part of the process. The IRS requires dissolution procedures included in a nonprofit’s Articles of Incorporation to ensure proper termination when the time comes.

Nonprofit organizations are legal entities. Shutting one down has implications for taxes and assets. While the dissolution process is similar for all organizations, it’s important to understand why nonprofits close.

Why a nonprofit organization closes

All nonprofit organizations have a natural lifespan. For some, the organization does last for many generations, while others close after a few years. Closing a nonprofit is a natural part of the organization’s process.

There are many reasons a nonprofit organization closes. The most common causes include:

Fulfilled Mission: Organizations with clear and focused missions do not last forever. For example, a nonprofit organization may set up in the wake of a natural disaster to coordinate relief efforts and fundraising. Once victims’ houses are rebuilt and relief is no longer necessary, the nonprofit’s mission is complete. In some instances, organizations adapt their mission to focus on other relief efforts and needs, but some choose to close having met the community need.

Financial Issues: Unfortunately, many organizations close due to a lack of funding or not investing enough funding into the organization. Fundraising is complex and requires the total dedication of the Board. Without consistent and varied sources of revenue, all nonprofits are in jeopardy of closure.

Unsupported Overhead: To ensure resources are properly allocated, most new nonprofit organizations should expect to diversify their funding with a 70/30 split – 30% for overhead (buildings, equipment, and training) and 70% toward mission fulfillment. As the organization grows, resources will expand into developing staff that supports the nonprofit. With the first three years, 60% of nonprofits are financially able to support staff members who help grow the nonprofit and expand its reach within the community. Paid staff are often one of the nonprofit’s most significant expenses, so ensuring constant fundraising is necessary after hiring the organization’s first staff person. Further, a 2009 Stanford study revealed that far too many nonprofits don’t spend enough money on overhead which can quickly lead to organizational collapse.

Leadership Change: Most nonprofit organizations are led by a public Board of Directors intended to function independently of a single leader. However, far too many nonprofits operate with a strong founder who does everyone else’s work, using the Board as a mere legal requirement. When do-it-all leaders inevitably burn out, move on, retire, or pass away, then the nonprofit leadership falls apart. Many uninvolved Boards find it far simpler to close than to try and fill the shoes of the previous leader.

External Factors: Nonprofit organizations do not operate in a vacuum and are at the mercy of external factors that affect operations and the ability to fundraise. The COVID-19 pandemic disrupted operations around the world. In 2020, we surveyed 250 nonprofit leaders. 79% reported a decrease in revenue resulting from the pandemic, with 38% experiencing revenue declines of 50% or greater. The long-term effect of COVID-19 on nonprofits remains to be seen, but nonprofits are often not prepared for external factors like a community or national disaster.

Create an action plan to dissolve the organization

Regardless of why a nonprofit chooses to close, the dissolution process is the same. Let’s explore the steps all nonprofit organizations should follow.

Distribute assets

Even when a nonprofit dissolves for financial reasons, there are likely still assets that belong to the organization. These assets may be monetary (cash), physical (equipment, goods, and inventory), or intellectual (brand assets, permits, deeds, and trademarks). Dissolving a nonprofit requires accounting and distribution of all assets according to IRS regulations and the organization’s bylaws.

Assets of a dissolving nonprofit must be donated to a tax-exempt or government entity for charitable purposes. Finding an organization to donate to is an excellent way for the Board of Directors to close the nonprofit that still honors its mission. For example, a nonprofit focused on helping homeless individuals may donate its assets to a local shelter upon closure.

Assets cannot be given to an individual for private use. The Board cannot divvy up any remaining assets among themselves — that’s illegal.

The process of distributing assets is often complicated. Asset distribution should not occur until all the organization’s debts and liabilities are settled. It’s essential to consult with the nonprofit specialists at BryteBridge before making any decisions.

Communicate with stakeholders and the community

Communication is essential for every nonprofit, especially when it chooses to close. Informing donors, volunteers, clients, and the community about closing is often the most challenging part of the dissolution process, but it’s also essential.

Draft a letter that succinctly conveys the closure message while celebrating the legacy and success of the organization. Even if the nonprofit only operated for a short period, highlight accomplishments

along the way. A well-drafted closure message is also an opportunity to highlight similarly-focused organizations as alternatives for clients, volunteers, and donors.

Distribute the letter physically or digitally to current donors and volunteers while publicly posting on the organization’s website and social media. Depending on the organization’s size, a press release may also be a good idea to notify the community.

Complete state dissolution process

Every state has a unique process for the dissolution of a nonprofit organization. Here are the steps most organizations will undertake (Note: the terminology, departments, or order may be different in your state):

  • Office of the Attorney General: Most states require nonprofit organizations to file Charity Registrations or Solicitation Permits with the Attorney General’s office. Nonprofits must notify the office that they will no longer accept donations or charitable contributions.
  • Department of Revenue: While nonprofit organizations are exempt from taxes, they still must file tax returns in most states. As such, the dissolution process often requires filing a final tax return with the state and receiving a response back confirming the organization met all outstanding tax liabilities.
  • Division of Corporations: All states have a dissolution process requiring a final filing to terminate the entity. Often called Articles of Dissolution, the document will finalize the dissolution process at the state level. Contact the nonprofit professionals at BryteBridge to ensure your organization does not incur potential penalty fees, tax liabilities, or issues during the dissolution process.

Terminate tax-exempt status with the IRS

Once all previous steps are complete, the last part of a nonprofit organization’s dissolution process involves the IRS. There are two routes to dissolution that depend on the organization’s current tax-exempt standing:

Organizations in good standing

A nonprofit is in good standing with the IRS so long as the tax-exempt status is active and the organization is listed in IRS Master List. These organizations have the most straightforward route to terminating tax-exempt status and closing the nonprofit’s EIN. The process involves filing a final tax return with the IRS depending on the organization’s last year of revenue, its foundation status, or filing requirements.

Less than $50,000

  • File a 990-N and answer “yes” when asked if the organization closed.

Less than $200,000

  • File a 990-EZ and check “terminated” in Item B on page one.
  • Answer “yes” when asked if the organization closed or liquidated.
  • Complete a Schedule N describing the “Liquidation, Termination, Dissolution, or Significant Disposition of Assets.”

Over $200,000

  • File a 990 and check “terminated” in Item B on page one.
  • Answer “yes” when asked if the organization closed or liquidated
  • Answer the question about distributing assets
  • Complete a Schedule N describing the “Liquidation, Termination, Dissolution, or Significant Disposition of Assets.”

Private Foundation

  • File a 990-PF and check “Final” in Item G.
  • Attach a statement that includes:
    • A description of asset transactions
    • A certified copy of the liquidation plan
    • A list of names and addresses receiving assets
    • An explanation of the asset value
    • A list of dates when distributions were made

Church or otherwise not required to file 990s

  • Send a physical letter to the IRS TEGE Correspondence Unit (P.O. Box 2508, Room 6403 Cincinnati, OH 45201) with:
    • Copies of all state dissolution documentation
    • Meeting minutes confirming a vote of termination
    • A list of the final Board Members with daytime phone numbers
    • A signed statement describing the final distribution of assets.

Organizations not in good standing

A nonprofit is not in good standing with the IRS when the tax-exempt status is revoked for failure to file annual tax returns, and the organization is listed on the Automatic Revocation of Exemption List. While it may seem like the organization’s status was terminated and therefore dissolution steps are unnecessary, the nonprofit still exists and likely has a significant tax liability.

The IRS imposes late fees of $20/day (up to $10,000 per return) for every past-due 990 for organizations with less than $1 million in revenue. Should the nonprofit earn more than $1 million in gross income, the IRS increases late fees to $100/day. These fines and reporting requirements do not go away. Since EINs are tied to an individual’s SSN, forming a future nonprofit could prove difficult. Additionally, avoiding IRS filings is an unethical approach to managing a nonprofit, even one being dissolved. For these reasons, the first step of dissolving an organization that is not in good standing is reinstatement.

While it may seem counterintuitive, reinstating the nonprofit by filing past due tax returns and reapplying for tax-exempt status brings the organization back into good standing. Reinstatement also addresses issues with late or missing state filings, which are often required to file Articles of Dissolution.

Once an organization returns to good standing, the termination process is identical to that listed above.

Conclusion: How to dissolve a nonprofit organization with the IRS

Dissolving a nonprofit’s tax-exempt status with the IRS occurs when filing the final 990 tax return. However, there are many things a nonprofit organization must do before notifying the IRS of dissolution. Following the correct dissolution procedure ensures legal and ethical compliance of the closing nonprofit organization. Has your nonprofit organization decided to close? Contact the nonprofit professionals at BryteBridge today.