Could you turn your business into a nonprofit?

If you run a for-profit small business, you may wonder whether it's possible to change to a nonprofit business model. In most cases, the answer is yes. Converting your for-profit to a nonprofit is likely possible, but you'll want to consider several important factors before moving forward.

Consider your reasons for making the change

First and foremost, examine your reasons for changing your status from for-profit to nonprofit. For example, you may be primarily tempted by the tax-exempt status given to many nonprofits. But converting to a nonprofit goes beyond tax concerns.

When a for-profit business converts to a nonprofit, its mission changes dramatically. A for-profit business runs its operations primarily to make a profit. When you operate a nonprofit, making a profit can no longer be your main purpose.

Running a nonprofit comes with other changes you wouldn't encounter in a for-profit business. For example, you will lose the level of control you held over the business as the owner once it becomes a nonprofit. Nonprofits must be run by boards of directors that make decisions based on the organization's nonprofit purposes.

Your reasons for making the change should center on your business purposes and goals. If your business is focused on pursuing a charitable or social welfare purpose, and your current mission is to provide a public service or public good, converting to a nonprofit may be a good route.

Determine your eligibility

Before you decide to turn your business into a nonprofit, consider whether your business is eligible for tax-exempt status under Section 501(c)(3) of the Internal Revenue Code. For many nonprofits, attaining 501(c)(3) status means the difference between survival and failure, so determining your eligibility should play a crucial role in your decision.

Your tax-exempt status application won't be approved if your company isn't operated and organized for an exempt purpose. According to the Internal Revenue Service (IRS), "exempt purposes" under Section 501(c)(3) means purposes that fit within the following: "charitable, religious, educational, scientific, literary, testing for public safety, fostering national or international amateur sports competition, and preventing cruelty to children or animals."

Beyond these exempt purposes, the IRS has other requirements for 501(c)(3) organizations. From a profit perspective, one of the most important is the requirement that none of the business' profits can be distributed for the benefit of private shareholders or individuals. Another important requirement is that your business doesn't pursue a nonexempt purpose other than incidentally.

How to go from for-profit to nonprofit

Once you've determined your eligibility to apply for 501(c)(3) tax-exempt status and you've decided the nonprofit route is best for your company, here's what you need to do:

• Convert to corporate status: All 501(c)(3) tax-exempt organizations must be incorporated. Depending on your current business structure, you may have to convert to a corporate structure. State laws vary when it comes to this conversion. For example, if you currently run your business as an LLC, your state's laws may allow you to simply convert your entity structure to a corporate structure through appropriate filings. However, some states don't permit this, and you may need to incorporate a new nonprofit entity, then transfer your LLC's assets to this new entity.
• Amend your articles of incorporation: If your business is already incorporated, changing to a nonprofit might only require that you amend your articles of incorporation to reflect your new, nonprofit purposes and file the amended documents with the appropriate authority. Again, check your state's laws and regulations regarding such changes to ensure you comply with government requirements.
• Apply for 501(c)(3) status: To apply to the IRS for tax-exempt status under 501(c)(3), fill out and file Form 1023. A lot hinges on being approved, so be sure to fully and accurately fill out the document. If your application is approved, the IRS will send you a determination letter stating that your business has been recognized as exempt under 501(c)(3).
• Apply at the state level: Depending on your state, you may also have to register as a nonprofit or apply for exemption from state taxes. If you run your business in multiple states or plan to solicit donations from a number of states, you should check the requirements set out by each state where you'll be operating.

Maintain your nonprofit status

Nonprofit compliance doesn't end with these initial rounds of paperwork and filings. Once you've converted to nonprofit status, you'll need to regularly file any required paperwork, both federal and state (if applicable), to maintain your tax-exempt status.

For example, the IRS requires that most 501(c)(3) organizations file Form 990 annually. Individual states may also require nonprofits to file reports each year.

With all of these factors to consider, a consultation with an attorney experienced with nonprofits may be invaluable.