Nonprofit Accounting Basics

The Basics of Nonprofit Dissolution

Note: Articles published before January 1, 2017 may be out of date. We are in the process of updating this content.

Updated: 
Oct 15, 2020
Author: 

Benjamin Takis

Takis Nonprofit Law PLLC | Sustainability Education 4 Nonprofits

Weathering the storm of major financial disruptions is a challenge for all organizations. Unfortunately, not all nonprofits will be successful, and inevitably some will have to shut their doors and dissolve. It is important to be aware that dissolution is a complex process that requires careful planning.

First, the Board must arrive at the decision to dissolve through careful deliberation after considering many alternatives. Shutting down an organization can draw increased scrutiny from state regulators and the general public (especially if the organization is well-known). Thus, the Board should review the circumstances that led to the decision to shut down, think carefully about a responsible strategy for dissolution, adopt a formal plan of dissolution (as discussed further below), and document these efforts meticulously.

The organization should be transparent with staff, constituents, and the community it serves about the organization’s plans, so as to minimize the disruption on these stakeholders as much as possible. In addition to being the right thing to do, advance notice to employees may be required under the federal WARN Act and/or analogous state laws. If the organization desires to pay severance to the employees who will lose their jobs, this will need to be factored into the financial plan (while being mindful of federal excess benefit transaction rules that prohibit paying more than reasonable compensation to “disqualified persons” including certain top management employees).

Likewise, the organization will need to review its existing commitments and contracts with grantors and vendors and maintain open lines of communication in the event shutting down entails termination of these arrangements. For organizations with substantial debts that cannot be paid, the bankruptcy process may be necessary.

Managing the organization’s remaining assets will also require substantial planning. Some assets may need to be liquidated and sold, which can require considerable time and effort. If there are cash and other assets left over after debts and vendors are paid, the organization will need to have a plan for distributing these assets for charitable purposes (in accordance with the dissolution provisions in the organization’s Articles of Incorporation). In most cases, this will involve granting the assets to other active 501(c)(3) organizations.

Next, the Board will need to commence dissolution proceedings under state law, including the approval and filing of “Articles of Dissolution.” This process varies by state, but generally any creditors must be notified in advance (directly and/or through an announcement in a newspaper) and a plan for the distribution of assets must be included. A separate notice to the state Attorney General’s office is sometimes required.

It is advisable to prepay as many of the final expenses as possible, such as document storage fees, attorney fees, and fees to file the last Forms 990. Organizations should hold in escrow an appropriate amount of cash in reserve for as long as the tail insurance is maintained in order to pay the deductible under the insurance policy in the event a claim arises. The Board will need to approve the granting of any remaining reserves to a pre-determined 501(c)(3) organization, as well as backup plans in the event this organization no longer has 501(c)(3) status at this time.

Filing the Articles of Dissolution is typically not the end of the process. It is usually advisable to maintain records and documents and purchase “tail” insurance for a certain period of time corresponding with the statutes of limitation on potential claims (generally 3 years). And organizations will need to continue filing Forms 990 until all assets have been distributed and the bank account is closed out with a zero balance. The last Form 990 must show zero assets and will be marked as the “final return.” In some states, one final filing in addition to the Articles of Dissolution is required once all these steps have been completed (this is sometimes called “Articles of Termination”).

The decision to shut down an organization is often one of the hardest ones that a Board will make, and the process of dissolving and winding up operations can be no less challenging.