Drafting Dissolution Language for the Articles of Incorporation
The “dissolution” clause in a nonprofit organization’s Articles of Incorporation is one of the key provisions required to qualify for 501(c)(3) status. This language must require that the organization’s assets remain dedicated to 501(c)(3) exempt purposes in the event it dissolves. While this basic principle is easy to understand, many overlook the significance of subtle differences in how to approach drafting this language.
To qualify for 501(c)(3) status, an organization’s governing documents must satisfy the “organizational test,” among other requirements. In general, this is accomplished by having a properly drafted “purpose” clause (as we discussed in this article) and “dissolution” clause in the Articles of Incorporation. Together, these provisions help ensure that the organization’s assets are used in a manner consistent with 501(c)(3) purposes throughout the entirety of its existence, from beginning to end.
There are two common approaches to the drafting of dissolution language, although many variations exist within these options:
An open-ended requirement to distribute any remaining assets for 501(c)(3) purposes upon dissolution; and
A more specific requirement to distribute any remaining assets to one or more other 501(c)(3) organizations upon dissolution.
Open-Ended Approach
The sample dissolution clause wording provided by the IRS in the Form 1023 Instructions is an example of the open-ended, more flexible approach:
“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.”
The benefit of this approach is that it satisfies IRS requirements while leaving open as many options as possible for the future. For example, distributing assets “for one or more exempt purposes” is broad enough to include distributing all of the organization’s funds on its programs and/or serving its charitable beneficiaries (such as providing scholarships to individual students), subject to any requirements that may apply under state law. Distributing assets to other 501(c)(3)
The downside is that having too many options with few specific parameters can lead to added stress and confusion, particularly if the Board does not have a clear understanding about what it means to distribute assets “for one or more exempt purposes.”
More Specific Approach
An example of dissolution language requiring an organization’s remaining assets to be distributed to one or more other 501(c)(3) organizations might read as follows:
“Upon the dissolution of this organization or the winding up of its affairs, subject to the discharge of valid obligations of the organization, the organization's assets shall be distributed exclusively to one or more nonprofit organizations which then qualify under the provisions of Section 501(c)(3) of the of the Internal Revenue Code, or corresponding provisions of any future federal tax code, as is (are) selected by the organization’s Board of Directors.”
While this approach provides somewhat less flexibility, it does not totally restrain the Board’s options. For example, as with the open-ended approach, this language would generally permit an organization to spend down its assets on current programs and gradually resolve its contractual obligations prior to commencing dissolution.
The difference is that this language makes it clear that once the formal dissolution process under state law has been initiated the ultimate recipient of the organization’s remaining assets must be one or more other 501(c)(3) organizations.
Some organizations specifically identify the recipient organization(s) in their Articles or require the recipient organization(s) must share the same mission or purpose as dissolving organization. These additional details are not required but are permissible so long as the 501(c)(3) status of the recipient organization(s) is verified prior to disbursement of the funds.
Defining the end goal in this way can be helpful to clarify the process and keep Board and staff focused on bringing the organization’s activities to a close and deciding on the recipient organization(s). For this reason, I tend to favor this approach unless the organization’s unique mission or circumstances require more flexibility.
Planning Tip – For certain extraordinary decisions such dissolution, amending the Articles of Incorporation, and/or making major programmatic changes, consider imposing a supermajority voting requirement and/or additional procedural hurdles (e.g. a 30-day notice period) in the organization’s Bylaws. While flexibility in decision-making is usually desirable, adding constraints is sometimes appropriate to help ensure that certain major decisions get the thought and attention they deserve.
Note that the IRS permits organizations incorporated in certain specific states to rely on the “operation of state law” in lieu of having specific dissolution language in the Articles of Incorporation. However, in all cases you should consult competent legal counsel to discuss these and other issues before drafting your organization’s governing documents.
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