Note: This article is based on Minnesota law. The law in other jurisdictions may vary.
Most nonprofit organizations—including charities, churches, hospitals, and schools—eventually come to an end. As an organization’s Board of Directors prepares to close the doors and terminate, it needs to determine what to do with the organization’s remaining funds. That is, the nonprofit’s funds need to be distributed somewhere. This article focuses on which 501(c)(3) organizations the funds can be given to.
Considerations as a Nonprofit Prepares to Dissolve
When a nonprofit is preparing to close, two initial guidelines apply:
First, a nonprofit should use its funds to pay any outstanding bills and debts. This may include setting aside some money for the accountant who will do the final IRS return and the attorney who will assist in terminating the organization.
Second, a nonprofit cannot donate any funds to people, businesses, or organizations that are not recognized by the IRS as a 501(c)(3), with possible exceptions for churches that never sought 501(c)(3) recognition. Nonprofit funds must generally be donated to 501(c)(3) organizations or to the government.
Most organizations don’t want to give their funds to the government, so they need to decide which 501(c)(3) organizations the funds should be given to.
Here is the bottom line: a nonprofit is least likely to encounter legal problems if the nonprofit donates funds to 501(c)(3) public charities that most closely align to the nonprofit’s historical purpose and practices.
Examples of Improper Donations
Here is an obvious example of improper donations: if a nonprofit was active in supporting a particular cause, it would be improper to donate funds to an opposing cause (“Cause #2”) because the nonprofit’s donors did not contribute to the nonprofit to support Cause #2.
Similarly, if a nonprofit was neutral regarding a particular cause, and was never active in supporting that cause, it would be improper to donate funds to that cause because donors did not contribute to the nonprofit to support that cause.
Legal Background: Charitable Trust Law
When money is donated to be used for a particular charitable purpose, that money is deemed to be subject to a “charitable trust.” See Minn. Stat. § 501B.31, subdiv. 4(b); Schaeffer v. Newberry, 235 Minn. 282, 286 (Minn. 1951). State law provides:
If a gift, trust, or devise has been made for a charitable, benevolent, educational, religious, or other public use or trust, or upon a condition, limitation, or restriction of any kind, the property given, entrusted, or devised may be used only for that use or trust and in accordance with the condition, limitation, or restriction.
Minn. Stat. § 501B.31, subdiv. 4(b)
Put another way, “[a] charitable trust is a fiduciary relationship with respect to property arising as a result of a manifestation of an intention to create it, and subjecting the person by whom the property is held to equitable duties to deal with the property for a charitable purpose.” City of Palm Springs v. Living Desert Reserve, 70 Cal. App. 4th 613, 620 (Cal. Ct. App. 1999) (citing Rest.2d, Trusts, § 348).
If it is “impracticable, inexpedient, or impossible” to literally comply with the terms, the money should be donated or used “as nearly as possible, [to] accomplish the . . . intention of the grantor . . . .” Minn. Stat. § 501B.31, subdiv. 4(c).
A breach of this trust gives rise to an action against the trustee, which in Minnesota is enforced by the attorney general. See Minn. Stat. § 501B.31, subdiv. 5; Schaeffer v. Newberry, 235 Minn. 282, 286 (Minn. 1951).
Thus, a dissolving nonprofit should donate its funds to 501(c)(3) organizations that will use the funds in a manner consistent with the nonprofit’s historical mission and purpose.