Closing a charity well

This guide is for board members of a small charity that is thinking about stopping. Maybe the founder is moving on and no one can take over. Maybe the money has dried up, or the need you were set up to meet has been met. Closing can feel like failure. It isn't. Closing carefully, so that people are paid, promises to donors are kept and what's left goes on doing good, is one of the most responsible things a board can do. After reading, you'll know the main steps, in order, and where state rules come in.

When to consider closing, or merging

Signs it may be time to talk about it:

• You've used up your reserves and can't see where next year's money will come from.
• The founder or the one person holding everything together is leaving, and no one can step in.
• Another organization now does the same work, better or at larger scale.
• The board can't find enough members to meet, or keeps missing filings.
• Your mission is complete.

Have the conversation early, while you still have money and choices. A charity that closes with some cash left can pay everyone, keep its promises and hand on its work. One that waits until the bank account is empty has far fewer options.

Merging as an alternative

Before deciding to close, ask whether your work could carry on inside another charity. A merger joins two organizations into one. Other options include transferring a program, its staff or its supporters to another charity, or becoming a project of a fiscal sponsor. These keep your work alive and can save the effort of setting everything up again. A merger is a legal transaction with its own steps under state law, and the IRS treats a charity that merges into another as ending: its final Form 990 is marked as a final return. Get advice from a lawyer who works with nonprofits.

Step 1: The board decides, and members vote if required

The decision to dissolve (formally end) the corporation belongs to the board, and sometimes the members too. Read your bylaws and articles of incorporation first. They may set a special vote, or require approval by voting members.

State law sets the rules too, and they vary. Two examples:

• California. The Attorney General says the first step is approval by a majority of the board of directors or members, or both, to wind up and dissolve. A certificate of that decision is then filed with the Secretary of State and sent to the Attorney General's Registry of Charities and Fundraisers.
• New York. The Attorney General's guidance for charities with assets says the board must adopt a Plan of Dissolution and Distribution of Assets. If the corporation has voting members, the plan then needs a vote of at least two-thirds of the members at a meeting with a quorum, or the unanimous written consent of the members.

Record the vote carefully in the minutes. You will need a copy later.

Step 2: Make a plan and keep filing

Write a short wind-down plan: what happens to each program, who will be told and when, how debts will be paid, where remaining assets will go, and who is responsible for each task.

Keep up with your filings while you wind down. California says a charity must be current with the Attorney General's Registry before it can dissolve. New York says charities that must register with the Attorney General's Charities Bureau must keep up their registration and annual financial reports before dissolving. Falling behind now can stall the whole process.

Step 3: Pay what you owe

Before any assets are given away, pay your debts: final wages, payroll taxes, rent, suppliers, loans. Return or settle any grant money you can no longer spend as promised, following the grant agreement. Tell funders early; many will work with you.

New York's guidance gives a time limit: once the plan is approved, the corporation must carry it out, pay its liabilities, distribute its assets and wind up its business within 270 days.

Step 4: Give remaining assets to another charity

A charity's assets don't belong to its board, founders or members. They are held for charitable purposes, and they stay that way when you close.

This is what your dissolution clause is for. IRS Publication 557 explains that a 501(c)(3)'s organizing document should ensure its assets are distributed for an exempt purpose if it dissolves, and that if the clause names a recipient, that recipient must be a qualified 501(c)(3) at the time of dissolution. Read yours; it may decide where your assets go. Our guide to articles of incorporation explains the clause.

State law adds its own rules. New York's guidance says a charity's assets must go to tax-exempt charitable organizations engaged in activities substantially similar to the dissolving charity's, as approved by the Attorney General or a court, and that gifts given for a specific purpose must keep that restriction with the new charity. Before you choose a recipient:

• Pick a charity whose work is as close as possible to yours.
• Check that it is a current 501(c)(3) in good standing.
• Pass restricted funds on with their restrictions, and tell the recipient in writing.
• Never give assets to a board member, staff member or their family, or sell to them below fair value.

Step 5: State approval and final filings

In many states the Attorney General oversees charities, and some require notice to the Attorney General, or approval, before a charity can dissolve. Our two examples:

• California. The Attorney General must issue a waiver of objections to the dissolution and the distribution of assets. A public benefit corporation asks for it by letter, signed by a director or attorney, with balance sheets for its last three years of activity showing where the assets went, and other documents the Attorney General lists. The Attorney General says there is no fee unless the charity is behind on its filings. The waiver letter is then filed with the Certificate of Dissolution at the Secretary of State.
• New York. Dissolution is a two-step process. First, the charity asks the Attorney General, or a court with notice to the Attorney General, to approve its plan. Then, after carrying out the plan and preparing a final financial report showing no assets or liabilities, it asks the Attorney General to approve its Certificate of Dissolution.

For your own state, start with your state charity regulator and your secretary of state.

Step 6: The final Form 990

The IRS says most organizations must tell it when they terminate, and that doing so closes the organization's IRS account and should stop letters about missed returns. How you do it depends on which return you file:

• Form 990-N (e-Postcard): answer yes to the question asking whether the organization has terminated or gone out of business.
• Form 990 or 990-EZ: check the Final return/terminated box at the top of the return, answer yes to the question about liquidating, terminating or dissolving, and complete Schedule N (Liquidation, Termination, Dissolution, or Significant Disposition of Assets). The IRS says Schedule N asks for a description of the assets and any transaction fees, the date of distribution, their fair market value and the recipients. It also asks whether any of your officers, directors, trustees or key employees will be involved in the organization receiving the assets.
• Attachments: the IRS says to include a certified copy of your articles of dissolution or merger and the resolutions and plans of liquidation or merger.

When it's due: the IRS says that if you terminate before the end of your normal tax year, your tax year closes early, and the final Form 990 or 990-EZ is due by the 15th day of the 5th month after the termination date. For example, a calendar-year charity that terminates on August 31 must file its final return by January 15. The Form 990-N is a notice, not a return: the IRS says a 990-N filer that terminates early should file its final e-Postcard as soon as reasonably practicable after the start of what would have been its next tax year.

Employees and records

If you have staff, tell them as early as you honestly can, and pay final wages on time. Your state may set deadlines for final paychecks. IRS Publication 15 says that if you go out of business you must file a final payroll tax return for the last quarter in which wages are paid; the form instructions explain how. Also close state payroll and unemployment accounts.

Before the doors close, decide who will keep the charity's records: minutes, financial records, tax returns, the dissolution papers and the IRS and state approvals. Name one person, usually the last board chair or treasurer, and tell your accountant where they are. Questions can come up years later.

Closing checklist

• We read our bylaws and articles, including the dissolution clause
• The board (and members, if required) voted to dissolve, and it's in the minutes
• We wrote a wind-down plan with a named person for each task
• Our state and IRS filings are up to date
• We told staff, funders, partners and the people we serve
• All debts, final wages and payroll taxes are paid
• Unspent restricted grants are settled with funders
• We have any state approval needed before distributing assets
• Remaining assets went to a 501(c)(3) with similar work, with restrictions passed on
• The final Form 990 is filed, marked final, with Schedule N
• Dissolution is filed with the secretary of state
• Someone is named to keep the records

If you'd like to talk to someone who has closed or merged a small charity, ask a member charity for help through the Exchange.