Nonprofit Legal Pitfalls: A Complete Guide to Avoid Disaster

by | Aug 20, 2020

nonprofit legal pitfalls

Nonprofit organizations often are made up of people that care about their communities and want to make a difference. They are committed to their causes and experienced in their own areas of expertise. 

But they are not necessarily experts at the legal considerations that go into starting and running a nonprofit organization. There are many nonprofit legal pitfalls that can sideline your 501(c)(3) before it gets going. Keep reading to learn more details about each one is and how to avoid it.

Nonprofit Legal Pitfalls

There are lots of laws that govern how nonprofits are set up and how they can operate. Most are made up of well-meaning people, but nonprofits are not immune from greed or fraud. 

The following are some of the most common legal issues nonprofits find themselves in, and how to avoid each one.

The Right Forms

Like so many things in a modern bureaucracy, it’s important to fill out the right paperwork and forms. The very first form is to simply write articles of incorporation to establish your nonprofit in your state. After that, in order to get 501(c)(3) status, you must start by filling out form 1023. 

This is a fairly long process. The form is 28 pages, but with all the accompanying documents and evidence, it could be about 100 pages when completed. 

The IRS takes nonprofit status seriously since it means the corporation has tax-exempt status. This form is like an audit into the nonprofit’s goals and methods. The government wants to make sure the organization is really doing what it says it is, and that it truly is benefiting the community. 

The other primary form that you’ll need to consider is Form 990. This needs to be completed each year. The form is the main way that the IRS and the public get basic information about the organization and its programs. 

Nonprofits don’t have to file for taxes, but they do have to file Form 990 to the IRS each year to demonstrate that they still deserve their tax-exempt status. 

How can you avoid any legal issues related to forms? Make sure to incorporate it correctly at the beginning. This may require seeking legal assistance to avoid mistakes. Follow all directions from the IRS and submit form 990 each year.

If you don’t turn one in for three years in a row, the company’s nonprofit status is revoked automatically.

Especially for large nonprofit organizations, the financial audits involved to prove you are in compliance can be intimidating. It is best to hire professional help. We offer financial audit assistance

Too Much Lobbying

Many people think that nonprofits can’t lobby or be political at all. This isn’t true, but there are limits. 501(c)(3) organizations can’t participate in specific political campaigns, but they can participate in some lobbying

After all, many nonprofits exist to address some common issues that groups lobby for. For example, it makes sense for an environmental nonprofit to lobby on behalf of policies that help the environment.

They can’t only do this, though. It can only be a certain percentage of their activity. And they can’t campaign specifically for the candidate they think will best serve the environment–only for the issues themselves. (It might not be hard for the public to figure it out, though!)

How can you avoid this? You will want to have an expert on the board or staff to help monitor the activities of the nonprofit. It should be someone familiar with the law or with public policy. For large nonprofits, it shouldn’t be too difficult to find qualified board members. 

For smaller nonprofits, this might not be possible. In that case, it may be better to avoid lobbying altogether. Lobbying tends to be more important to larger nonprofits anyway.

Victims and Unhappy Employees

It goes without saying that things like workplace bullying and sexual harassment are terrible behavior, even apart from any legal consideration. But this article is about avoiding legal trouble, and these types of behavior almost always lead to legal action against the nonprofit. 

If employees don’t feel safe at work and end up as victims of sexual harassment or any type of bullying, they will likely sue. 

What can be done to avoid this? Having solid internal processes for dealing with issues before they become worse is the best way. The board should develop (or approve) a system for dealing with human resource complaints.

The board should make it clear that management will listen seriously to all complaints and take action when appropriate. The system should be easy to use, as well. 

In a worst-case scenario, the board or the management should fire any employees responsible for illegal or unethical behavior. This can go a long way toward preventing further legal action. 

On a slightly less serious note, even unhappy employees who have not been victims may be more prone to create legal trouble. So, it is best to treat employees with respect at all times. The happier they are, the fewer legal problems the organization will likely have. 

Conflicts Of Interest 

Nonprofits typically have lots of partnerships with other nonprofits, volunteers, and board members. The community collaboration is a good thing, but it does create chances for conflicts of interest. 

For example, if a CEO for a drug manufacturer is on the board of a nonprofit health center, there could be a conflict of interest when it comes to choosing medications. These types of conflicts are not bad in themselves.

To avoid any legal action, nonprofits just have to be aware of the potential conflicts and make them public. As long as the conflicts of interest don’t lead to breaking the law or unethical behavior, it’s fine.

Get More Information

Please contact us for more information on ways to avoid nonprofit legal pitfalls. We can assure your nonprofit does not run into legal trouble because of financial or accounting issues. Your focus should be on completing your mission to help your community!


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