What Happens To A Nonprofit’s Funds When It Goes Under?
Despite amassing billions of dollars in charitable contributions every year, a surprising number of nonprofits (about 30%) don’t survive beyond a decade. With 1.8 million tax-exempt organizations operating in the United States today, this churn amounts to thousands of nonprofits dying on an annual basis.
From a donor’s perspective, it’s worth asking: Could a nonprofit’s dissolution introduce the temptation for its leaders to misappropriate assets or commit fraud?
While documented cases of misconduct during dissolution are relatively rare, understanding the potential risks and implementing preventive measures are critical for maintaining public trust.
Legal framework governing nonprofit dissolutions
Tax-exempt organizations are legally required to follow a structured dissolution process, which includes settling their outstanding debts and filing a final Form 990 tax return detailing their asset distribution plans. In notifying the Internal Revenue Service of their closure, nonprofits must disclose a description and fair market value for each disposed asset, the recipient(s), dates and transaction fees.
When a nonprofit organization dissolves, IRS Code 501(c)(3) requires that its remaining assets be allocated exclusively to another charitable entity or a federal, state or local government for a public purpose.
Organizations are also prohibited from distributing any property to individuals, including board members, employees or volunteers, during the dissolution phase. In some cases, nonprofits may pay outstanding salaries or debts to individuals before closure, but surplus assets cannot be distributed as a windfall.
The IRS instructs nonprofits to include a dissolution clause in their organizing documents (like the example below):
However, the IRS does not directly oversee these transfers in real time. Enforcement often falls on state attorneys general, who may review and approve asset distributions before dissolution is finalized.
States have their own regulations over nonprofit dissolutions. California’s system charges the state attorney general with reviewing dissolution proposals, while New York requires nonprofit dissolutions to secure court approval before notifying the AG. In North Carolina, the secretary of state mandates a dissolution plan outlining how a nonprofit’s funds will be distributed.
How nonprofits could use dissolution to divert funds
Even with legal safeguards in place, the nonprofit dissolution process presents opportunities for financial misconduct with insiders siphoning off assets. While federal regulators are often focused on compliance over dissolution, state-level enforcement can be inconsistent due to understaffing for charity oversight. State AGs often intervene reactively in response to complaints rather than proactively scrutinizing every dissolution and transaction.
Smaller nonprofits, especially those under certain state audit thresholds (often $500,000 in revenue), may lack the oversight needed to prevent financial misappropriation. Without routine independent audits, it becomes easy for insiders to engage in self-dealing, whether through inflated administrative costs, payouts to leadership or questionable asset transfers.
In one case last April, the Kansas AG obtained a judgment against Southern Winds Equine Rescue and Recovery Inc. for failing to properly dissolve after the board approved its closure. The charity and its president continued raising donations for two years, transferring funds for for-profit and personal use. The AG’s order imposed $50,922 in damages and blocked the defendants from operating any charity in the state.
In another recent example last year, the Minnesota AG forced the dissolution of a youth soccer charity after investigating complaints about its governance. The agency found that All In Minnesota failed to hold meetings and appoint a treasurer to manage its books, which allowed for conflicted dealings between the founder and related entities, including a for-profit company. The charity had also closed in 2022 without following the state’s dissolution regulations.
Nonprofits converting into for-profit businesses
Some nonprofits choose to restructure as for-profit entities rather than dissolve, which could create additional loopholes for financial misconduct.
Although some states require approval before assets can be transferred to a for-profit, enforcement of these regulations varies, and oversight is often minimal. This is particularly troubling when valuable assets like real estate, intellectual property or financial reserves are transferred to a newly formed for-profit entity.
One recent example of a controversial restructuring is OpenAI, which formed in 2015 as a nonprofit but later transitioned into a hybrid “capped-profit” model to secure investment while retaining a nonprofit board. While the organization claims it still prioritizes public benefit, the move sparked debate over the extent to which nonprofit leaders can maintain control when transitioning to for-profit structures.
Elon Musk, a co-founder and early backer of the now-$157 billion enterprise, filed a lawsuit challenging OpenAI’s governance.
Later, OpenAI announced last December that it would turn its for-profit arm into a public benefit corporation, a move to “balance [the interests of] shareholders, stakeholders, and the public benefit in its decision-making.”
Overall, nonprofit-to-for-profit conversions are not inherently illegal, but any transfer of assets must be conducted at fair market value, with proceeds directed toward charitable purposes. At any point, if insiders attempt to acquire assets at artificially low prices or divert tax-exempt funds into private hands, they could face IRS penalties, excise taxes and legal action.
Positive examples: Dissolutions handled responsibly
Most dissolving nonprofits distribute their assets responsibly, with funds continuing to serve the public good. Take Immanuel Baptist Church in North Carolina, which recently shut down after 109 years due to declining attendance. The church sold its 40,000-square-foot property for $1.5 million and distributed the proceeds to more than 70 charities, including mental health services, scholarships and refugee aid. About 20% of the funds went to the Cooperative Baptist Fellowship, in line with the church’s mission and affiliation.
Some charitable foundations follow a limited-life model, defining a clear timeline for doling out funds. For example, former Buffalo Bills owner Ralph Wilson directed his foundation in 2014 to exhaust its $1.2 billion in assets within 20 years of his death, allowing Wilson’s impact to serve people who knew him in his 95-year lifetime.
Another structured closure was Atlantic Philanthropies. Billionaire Charles Feeney designed the foundation to spend its entire $8 billion endowment by 2020, spreading funds across education, public health and human rights programs.
Feeney’s “Giving While Living” philosophy believed philanthropy should aim to make an immediate impact rather than accumulate wealth in perpetuity.
This story originally appeared at MinistryWatch.
Shannon Cuthrell is a journalist with a background covering business, technology and economic development. She has written for Business North Carolina magazine, WRAL TechWire, Charlotte Inno and EE Power, among other publications.