Non-profits commonly get in trouble through financial mismanagement, such as mishandling restricted donor funds, failing to file annual IRS Form 990s, and violating tax-exempt regulations. Other major risks include poor governance, conflicts of interest, employment issues, and using copyrighted materials.
You may contact your state's charity oversight office, often housed within the attorney general's office, to file a complaint. These offices have the authority to investigate nonprofits for potential financial mismanagement, misuse of funds, or failure to comply with disclosure requirements.
Various methods have been developed over time to ensure that non-profit organizations are accountable to the authorities. They include disclosure of financial statements, evaluations, audit reports, internal controls feedback mechanisms, and assessments to name a few.
The "33 rule" for nonprofits usually refers to the IRS Public Support Test, requiring 501(c)(3) public charities to show they receive at least one-third (33 1/3%) of their support from the general public or other public charities over a five-year rolling period, distinguishing them from private foundations by ensuring broad community reliance. This is crucial for maintaining public charity status, involves reporting on Form 990 Schedule A, and can be passed through meeting the 10% "facts and circumstances" test if the main test is missed.
Nonprofits must address seven key legal issues, including tax-exempt status, governance, fundraising laws, employment compliance, contracts, IP protection, and data security. Failure to comply with nonprofit IRS compliance rules (like Form 990 filings) can result in losing tax-exempt status.
If the nonprofit is sued and lacks the proper planning and protection, you could lose your savings, your home and other assets. Nearly two out of three nonprofits reported a Directors & Officers liability claim within the past 10 years.
The IRS permits nonprofits to generate surplus funds, as long as those funds are then reinvested into activities that support the mission of the organization. The IRS has no issue with profit - rather they have an issue with that profit benefiting individuals, such as your staff or nonprofit board of directors.
Serving on a nonprofit board is a great way to give back and make new connections by sharing your professional skills with the community. However, you should consider your possible vulnerabilities, too. Both boards and board members can face lawsuits.
If there are large amounts of fundraising income, the IRS generally expects to see related amounts of fundraising expenses. The IRS may initiate an audit if it feels fundraising expenses are not in proper proportion to fundraising income.
A nonprofit treasurer is a team member who provides financial oversight for an organization. In most cases (although not all), the treasurer is a member of the board of directors and serves as the financial liaison between the nonprofit's board and staff.
One option is reporting directly to law enforcement. Another option is reporting to a state government, which exercises regulatory authority over the nonprofits incorporated within the state.
How to wind up a charity
Earning too much income generated from unrelated activities can jeopardize an organization's 501(c)(3) tax-exempt status. This income comes from a regularly carried- on trade or business that is not substantially related to the organization's exempt purpose.
If the entire board is in violation or is not being responsive, that may be grounds for a lawsuit or other formal legal action that may require involving external authorities. Again, seek legal advice about how to best proceed in order to resolve these issues.
A board governance/board development committee sets the pace, creates systems to wire in accountability, and ensures that the rules established for board members are followed, including ensuring that all nonprofit funds are accounted for in a transparent and compliant manner.
Common legal issues
What are the most common mistakes nonprofits make? Some of the most common mistakes include unclear missions, weak board engagement, poor donor communication, lack of financial transparency, and neglecting compliance requirements. Many of these issues are fixable with the right tools and support.
The 80/20 rule (Pareto Principle) for nonprofits suggests that roughly 80% of results come from 20% of causes, most commonly meaning 20% of donors provide 80% of donations, but it also applies to programs, volunteers, and marketing efforts, guiding organizations to focus resources on high-impact areas like major donors or effective programs for greater efficiency and fundraising success. It emphasizes donor stewardship, program evaluation, and targeted communications to maximize impact, though some argue for diversifying away from over-reliance on a small donor base.
Nonprofit entities must keep good records. They must record meetings of minutes and set up a separate bank account. All profits must be used in the organization's work and nonprofit organizations are not allowed to distribute profits to members for any reason.
Just Because an Organization is a Nonprofit Doesn't Mean It Can't Be Sued. Nonprofit organizations own vast amounts of real estate open to the public. If they're negligent in managing or maintaining it and someone is hurt, they may be subject to legal action that may recover compensation for those injuries.
Nonprofits use fund accounting to organize and allocate their money in accordance with the programs and activities the money was donated to support. Nonprofits can use either accrual- or cash-basis accounting to track the finances of their operation.