What Is Dissolution?
Dissolution is the termination or closing of an organization in its present state. There are various reasons an organization would need or want to dissolve. For example, the organization might have fulfilled its mission or lack sufficient resources to effectively carry out its work. Perhaps there is no longer a need for the organization’s services, or it is dissolving as a result of a merger.
Dissolution Requirements of a Charity
As noted in a prior post, for a nonprofit organization in the U.S. to be recognized as a charity under section 501(c)(3), it must be "organized and operated exclusively for charitable purposes"; it must not be organized or operated for the benefit of private interests; and no part of its net earnings may benefit private parties. In addition, it is restricted in regard to how much political and legislative lobbying activities it may conduct.
An organization is organized exclusively for charitable purposes only if, among other requirements, its governing documents or local law permanently dedicate its assets to charitable purposes (or to the government for public purposes) on dissolution. Specifically, the U.S. Treasury regulations provide that
An organization is not organized exclusively for one or more [charitable] purposes unless its assets are dedicated to a [charitable] purpose. An organization's assets will be considered dedicated to a [charitable] purpose, for example, if, upon dissolution, such assets would, by reason of a provision in the organization's articles or by operation of law, be distributed for one or more [charitable] purposes, or to the Federal Government, or to a State or local government, for a public purpose, or would be distributed by a court to another organization to be used in such manner as in the judgment of the court will best accomplish the general purposes for which the dissolved organization was organized.
Treas. Reg. 1.501(c)(3)-1(b)(4).
What Are Charitable Purposes?
The Treasury regulations broadly define "charitable" to include
Relief of the poor and distressed or of the underprivileged; advancement of religion; advancement of education or science; erection or maintenance of public buildings, monuments, or works; lessening of the burdens of government; and promotion of social welfare by organizations designed to accomplish any of the above purposes, or (i) to lessen neighborhood tensions; (ii) to eliminate prejudice and discrimination; (iii) to defend human and civil rights secured by law; or (iv) to combat community deterioration and juvenile delinquency.
Treas. Reg. Reg. 1.501(c)(3)-1(d)(2).
There are numerous resources that offer guidance on how to meet the dedication of assets requirement on dissolution, including samples of acceptable dissolution language, most notably in Revenue Procedure 2003-12 (PDF). For example, an organization may require that, on dissolution, "the assets of the organization will be turned over to one or more recognized charitable organizations." See Rev. Rul. 59-310 (PDF). Alternatively, a charitable organization's dissolution clause might require that assets on dissolution be distributed "for purposes identical to those of the organization," since the organization itself has exclusively charitable purposes. "Where the assets will be distributed for purposes identical to those of the organization, a provision to that effect is sufficient. The organization need not repeat the language that appears in its purposes provision." See Organizational Test – IRC 501(c)(3), Exempt Organizations - Continuing Professional Education (PDF).
However, an organization can also meet the dissolution provision requirement if, by operation of State law or court action, its assets would be distributed for one or more charitable purposes, or to the Federal government, or to a State or local government, for a public purpose, even though a specific dissolution provision is not contained in its governing document. See Treas. Reg. 1.501(c)(3)-1(b)(4).
When Are an Organization's Assets Not Dedicated to Charitable Purposes on Dissolution?
Equally important, the Internal Revenue Service has provided some clarity on when this requirement is not met. Dissolution clauses that are vague regarding the ultimate destination of assets or that do not permanently dedicate the assets to charitable purposes will not suffice. For example, the Internal Revenue Service has explained that "upon dissolution an organization's assets must be distributed for [charitable] purposes to be used in such a manner as to best accomplish the general purpose for which the dissolved organization was organized. … [It is not sufficient if the governing document] provides only that assets must be distributed to an organization 'engaged in activities substantially similar to those of the dissolving corporation.'" G.C.M. 39736 (June 6, 1988). Accordingly, an organization is not organized exclusively for charitable purposes if its assets are dedicated to "similar" purposes on dissolution.
When Are an Organization's Assets Dedicated to the Government for Public Purposes?
A charity's dissolution clause may also be sufficient if it dedicates the organization's assets on dissolution to a government entity for public purposes. A government entity might include a Federal Government agency or a State or local government agency, subdivision, or instrumentality, as long as the assets are dedicated to charitable or public purposes.