I am on the board of a very small water company that services about 25 properties. We are a member-owned nonprofit corporation that is now in the process of dissolving. We have about $6000 worth of equipment and cash but no other property or real estate. We recently received notice from the IRS that we lost our exempt status because we failed to file a Form 990 for three years. They are looking for two years of income tax. I am the newly appointed sec/treasurer of the association, and I didn't know that we were tax-exempt or that we were supposed to file an annual return. In view of our situation, how should we dissolve, and can we disperse funds to our members?
First, unless your tax is less than the filing fee to regain your exemption, I would recommend that you file with the IRS to recover your tax-exempt status retroactively to avoid the liability for income taxes. You can’t legally dissolve and distribute all of your assets to anyone as long as you have that debt outstanding. As a small nonprofit, with, I assume, an all-volunteer administration, you have a pretty good chance of getting reinstated. (See Ready Reference Page: “IRS Issues Procedures to Recover Lost Exemption”)
You should review your articles of incorporation and bylaws to see if they say anything about what happens to your assets on dissolution. Depending on your federal tax exemption and state law, you may be able to distribute the remaining net assets to your members. If you have (had) 501(c)(3) charitable status, you won’t be able to do it. But if, as is more likely, you had 501(c)(4) community organization status or some other non-charitable status, you may not be precluded by federal tax law from distributing the net remaining assets to your members, and your state nonprofit corporation law is likely to permit it.