Nonprofits exist to serve missions that matter. As organizations grow, so do their legal and compliance risks. It’s easy to lose focus on the fine print while pursuing impact, yet small oversights can put your tax-exempt status, and reputation, at risk.
Whether you’re expanding programs, adding staff, or diversifying funding, here are the five most common legal risks growing nonprofits face and how to avoid them.
1. Governance Gaps and Outdated Bylaws
Strong governance is the foundation of a healthy nonprofit. Yet many organizations operate under bylaws written years ago, long before new board members, changing programs, or updated IRS rules.
Look out for:
- Bylaws that don’t match how the board actually operates
- Missing or outdated conflict-of-interest policies
- No record of annual board approvals or minutes
Review your bylaws and governance policies every few years. Ensure they reflect current practices and IRS expectations. Provide board training on fiduciary duties so directors understand their responsibilities to the organization and to the public.
2. Mission Drift
The IRS grants tax-exempt status based on your stated charitable purpose. As your nonprofit grows, it’s natural to evolve. But when activities begin to stray from your original mission, you risk crossing into taxable territory or even losing exemption.
For example, a nonprofit formed to support literacy begins offering paid consulting services to corporations. This can be prevented by regularly reviewing your mission statement and programs. If your activities have expanded, consider amending your Articles of Incorporation or updating your IRS exemption to reflect your current purpose.
3. Unrelated Business Income (UBI)
Even nonprofits must pay taxes on income not substantially related to their mission. Renting out facilities, selling merchandise, or hosting events can generate unrelated business income that triggers IRS scrutiny.
To protect the nonprofit:
- Identify which activities may create taxable income
- Track them separately in your accounting system
- File the required Form 990-T when applicable
- Seek legal guidance before launching new revenue-generating programs
Your accountant and attorney can work together to ensure you’re reporting correctly and not jeopardizing your exemption.
4. Weak or Missing Contracts
As nonprofits grow, so do their relationships: with vendors, funders, and partners. Many rely on handshake deals or copied templates, which can lead to serious disputes.
Every partnership or grant relationship should have a clear written agreement outlining roles, responsibilities, intellectual property, and risk allocation. For collaborations or fiscal sponsorships, formal agreements are essential to maintain compliance and protect your assets.
5. Employment and Volunteer Issues
People are the heart of your mission but managing staff and volunteers brings legal risk. Common pitfalls include misclassifying employees as contractors, failing to follow wage and hour laws, or overlooking volunteer liability protections.
To protect the nonprofit, review employment policies, offer clear volunteer agreements, and confirm that your insurance and HR practices align with state and federal laws. A little attention now can prevent major disputes later.
Protecting What Matters Most
Compliance doesn’t have to be overwhelming. The key is building systems, legal, financial, and governance, that evolve with your organization.
Working proactively with your accounting and legal advisors ensures you stay aligned with IRS and state requirements while focusing on what you do best: advancing your mission.
Protecting your organization’s tax-exempt status isn’t just about avoiding penalties, it’s about safeguarding the trust your donors, partners, and community place in you.
