Best State to Start a 501(c)(3) Nonprofit: DE vs. NY

New York versus Delaware - what is the best state to incorporate a 501c3 nonprofit?

When starting a new nonprofit, a common question is “what is the best state to it incorporate in?” Particularly for our New York clients, seven-out-of-ten times, our answer is Delaware. What about the remaining three?

Four factors must be analyzed in choosing a state of incorporation flexibility, cost, home team advantage and reputation. Different nonprofits have different priorities, so the “best” state in which to form a nonprofit is the state that best reflects a particular nonprofit’s priorities based on this analysis. This blog post looks at these factors through the lens of two states: Delaware and New York.


Flexibility

A nonprofit’s state of incorporation determines what law governs the “internal affairs” of the nonprofit. A nonprofit’s “internal affairs” are the system of rules governing relationships between the nonprofit and its insiders (such as directors, officers and members). Choosing what law governs a nonprofit’s “internal affairs” is of paramount importance because it basically dictates what a nonprofit and its insiders, can or cannot do, what they must do, and how they need to get things done.

Rigid New York Nonprofit Law

New York incorporated nonprofits are subject to the New York Not-for-Profit Corporation Law (the “N-PCL”). The N-PCL is one of the most onerous nonprofit corporate laws in the United States. It imposes many restrictive and draconian requirements on the internal affairs of nonprofits. These include:

  • Age restrictions on directors;
  • An absolute minimum of three directors;
  • An absolute minimum of three members, for membership nonprofits;
  • A mandated conflict of interest policy;
  • A whistleblower policy for nonprofits of a particular size;
  • Special procedures and record keeping rules for approval of transactions between insiders and the nonprofit;
  • Annual newspaper publication requirements for private foundations;
  • Restrictions on who can be president, and special voting and record keeping rules if the president will also be an employee;
  • Maximum terms for directors (although there are no term limits);
  • Mandated super-majority voting for certain corporate decisions;
  • Mandated audit thresholds;
  • Stricter financial conflicts of interest rules than required by the Internal Revenue Service (IRS); and
  • Requiring the blessing of the New York attorney general or a New York court before a charitable nonprofit can take certain actions decided by the board or members, including expansion of the nonprofit’s mission, engaging in transactions involving a substantial amount of the nonprofit’s assets, and changing the law, moving out of New York, and even closing down.

While some of the above reflect corporate governance “best practices,” others are simply bureaucratic and superfluous. The N-PCL takes away the ability to choose what practices to follow, and forces it upon a nonprofit on pain of investigation by authorities and forced dissolution.

The N-PCL also can potentially hobble businesses and organizations that have close relations with a New York incorporated nonprofit. As indicated above, the N-PCL’s financial conflicts of interest rules are more strict than even those of the IRS because it extends restricted transactions to affiliates of a New York incorporated nonprofits and insiders of those affiliates (and their family members and controlled entities). So whereas a transaction between the spouse of a large donor of a nonprofit with a for-profit subsidiary business of a nonprofit would normally not be a problem for the IRS, if the nonprofit were a New York incorporated nonprofit, the transaction could subject the nonprofit, the for-profit and the spouse of the donor to investigation by New York authorities and possible penalties.

Flexibility for Delaware Nonprofits

But what if a nonprofit could operate in New York without these restrictions and requirements? It can! While New York’s N-PCL is one of the most restrictive nonprofit laws in the country, Delaware’s General Corporation Law (GCL), which covers both nonprofits and for-profits, is one of the most flexible. Delaware has none of the above N-PCL requirements and restrictions. With a few small exceptions and procedural issues (some things must go in the certificate of incorporation and not the bylaws), a nonprofit incorporated in Delaware can be structured in the manner it wants.

By incorporating in Delaware, a nonprofit chooses to be subject to the flexible “internal affairs” rules of the GCL, allowing the nonprofit to avoid many of the shackles imposed by the N-PCL, even if the nonprofit will operate or even be headquartered in New York. However, there is an important caviat. Regardless of the state of incorporation, a nonprofit may still be subject to state level charities regulations. For example, all nonprofits that have registered with the New York State charities bureau are subject to similar audit thresholds as those of incorporated in New York.

So, compared with New York, Delaware is the best state of incorporation in terms of flexibility.


Cost

Just as with a business, in order for a nonprofit to operate on a continuous and systematic basis in a state, a nonprofit needs to either incorporate in the state or register as a “foreign nonprofit” in the state. Registering as a “foreign nonprofit” increases both the startup cost and maintenance cost involved in running a nonprofit. The below costs are as of 30 June 2021.

New York & Delaware Nonprofit Incorporation Costs

The minimum cost of incorporating a nonprofit in New York is $85. This consists of:

  • $75 certificate of incorporation filing fee
  • $10 certified copy fee
  • $0 registered agent fee (as New York only requires a United States address, and not a registered agent)

The minimum cost of incorporating a nonprofit in Delaware is $184. This consists of:

  • $107 certificate of incorporation filing fee (based on a three-page certificate at $89 for the first page, and $9 for each additional page)
  • $50 certified copy fee
  • $45 registered agent fee (based on the lowest cost commercial Delaware registered agent service available)

The minimum cost for registering a Delaware incorporated nonprofit as a foreign nonprofit in New York is $195. This consists of

  • $50 Delaware certificate of good standing fee (to prove to New York that the Delaware incorporated nonprofit is a corporation in good standing in Delaware)
  • $135 New York application for authority filing fee (to register the Delaware incorporated nonprofit as a foreign nonprofit in New York)
  • $10 New York certified copy fee

New York & Delaware Nonprofit Maintenance Costs

The minimum annual cost for maintaining a nonprofit’s corporate existence or foreign registration in New York is $0. This is because

  • 501(c)s may apply to be exempt from the New York State $25 minimum corporate franchise tax and $25 minimum New York City general corporation tax
  • Nonprofits may be exempt from the annual filings with the New York charities bureau and New York department of state (each with a minimum filing fee of $25), depending on their income or activities
  • A registered agent is not required so there is no registered agent renewal fee

The minimum annual cost for maintaining a nonprofit’s corporate existence or foreign registration in Delaware is $70. This consists of

  • $25 annual report filing fee
  • $45 registered agent fee (based on lowest cost commercial registered agent)

New York & Delaware Overall Cost Comparison

Based on the above

  • For a New York incorporated nonprofit to operate in New York, the minimum startup cost is $85 and minimum annual maintenance cost is $0
  • For a Delaware incorporated nonprofit operating in New York, the minimum startup cost is $379 (cost of Delaware incorporation plus New York foreign registration), and the minimum annual maintenance cost is $70(

So, compared with Delaware, New York is the best state of incorporation in terms of cost.


Home Team Advantage

A state sometimes explicitly or tacitly provides preferential treatment to domestic nonprofits (those incorporated in the state). This may be in relation to access to certain grants, or to applications for certain licenses and permits. This is certainly true with New York.

We’ve noticed that some New York government entities prefer New York nonprofits in terms of grants, licenses and permits. Certain government forms and applications do not even provide necessary instructions, guidance or checkboxes, with respect to foreign nonprofits.

So, compared with Delaware, New York is the best state of incorporation for a nonprofit that will depend on New York preferred grants, licenses or permits because of the home team advantage.


Reputation

Finally, there is a marketing value to a nonprofit’s state of incorporation. A state’s reputation carries with it connotations of culture and prestige.

Thanks to scandals such as the Panama Papers, some people have the impression that people incorporate in Delaware for sleazy reasons, despite the fact that most publicly listed companies are incorporated in Delaware. For this reason, Delaware nonprofits may face resistance from unsophisticated donors or potential partners.

Conversely, New York sounds sexy, especially for nonprofits in certain fields such as the arts, and some nonprofits like to say that they are “New York nonprofits.” Donors and potential partners who, for example, are patrons of the art, may find donating to or working with a New York nonprofit more attractive than a Delaware one.

So, compared with Delaware, New York has a slight advantage as the state of incorporation in terms of reputation.


Conclusion

Ultimately, there is no one-size-fits-all approach to choosing a state of incorporation. Generally, if cost is no object, it is better to incorporate a nonprofit in Delaware rather than New York due to the flexibility that Delaware’s corporate law offers (and the draconian restrictions that New York incorporated nonprofits are subject to). However, at times, a nonprofit may be engaged in certain activities, work in a certain space, or seek to attract certain stakeholders, where it may be prudent to incorporate in New York due either to New York government preferences for certain grants, licenses and permits, or to the reputational advantages that New York brings in certain fields.

This blog post is provided for general informational purposes only. It is not legal advice, and should not be a substitute for legal advice. If you have questions or comments about the post, or would like to learn more about something in the post, please feel free to contact me.

Additionally, you may be interested in taking a look at my New York nonprofit law services.

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