Turning a business or project into a nonprofit

This guide is for founders who already run a small business, an LLC or a side project with a social mission and wonder whether it could become a nonprofit. It's a fair question, and sometimes the answer is yes. But a nonprofit isn't a business with a tax break: it's a different kind of organization, with no owners. After reading, you'll know what "converting" really involves, what happens to the business's assets and your pay, and what other options might fit better.

If you're still deciding whether to start a charity at all, see Should I start a charity? and try our structure tool.

A nonprofit has no owners

This is the heart of it. The IRS says a 501(c)(3) organization must be organized and operated exclusively for exempt purposes, and none of its net earnings may benefit any private shareholder or individual. This is called the rule against private inurement. The IRS explains that a "private shareholder or individual" means a person with a personal and private interest in the organization's activities, such as its founder or the founder's family. A related rule says the organization must not be run for private benefit, meaning for private interests. The glossary explains private inurement and private benefit.

So if you turn your business into a charity:

• You no longer own it. Nobody does. A board governs it for the mission.
• You can't sell it later and keep the money.
• If it ever closes, what's left must go to another charitable purpose or to government for a public purpose, not back to you. Publication 557 explains this "dissolution" requirement, and it must be written into the nonprofit's founding document.

If that's not what you want, a nonprofit probably isn't the right shape for your work. That's fine; see the alternatives below.

Why "converting" usually means starting a new organization

In most cases, a founder forms a new nonprofit corporation under their state's nonprofit law, with articles that meet the IRS's requirements, and then moves the activity into it. The new charity applies to the IRS for 501(c)(3) status. See the Forming your charity step for the order of steps.

The IRS will want to know about the history:

• You'll be a "successor." The Form 1023 instructions say you're a successor organization if you took over activities previously conducted by another organization, took over 25% or more of the fair market value of another organization's net assets, or were set up by converting an organization from for-profit to nonprofit status. Successors complete Schedule G of Form 1023 about the earlier organization, the predecessor. The instructions say a "for-profit" organization here is one in which people can have an ownership interest, which includes sole proprietorships and corporations.
• LLCs and the short form. The Form 1023-EZ instructions say LLCs can be eligible for 501(c)(3) status but can't apply using Form 1023-EZ. They use the full Form 1023, which asks for the LLC's articles of organization and any operating agreement.

Rules for changing one type of business entity into another are set by each state. Ask your secretary of state's office or a lawyer before you assume a business entity can be converted in place.

What happens to the business's assets

If the new charity takes over equipment, stock, a website, a lease or a customer list from your business, treat it as a deal between two separate parties:

• Gift, sale or lease? You can donate the assets, sell them, or lease them. Write down which, and why.
• Never more than fair value. If the charity pays you more than the assets are worth, charitable money flows to a private person, which is exactly what the inurement rule forbids. Get an independent valuation for anything significant.
• Use the conflict of interest process. The IRS's sample conflict of interest policy, in the Form 1023 instructions, says an interested person may present information but then leaves the meeting while the board discusses and votes, and the remaining directors decide whether the deal is fair and in the charity's best interest. The minutes record it.

Can you still be paid?

Yes, but only reasonable compensation for real work. The sample articles in Publication 557 say no part of the net earnings may benefit members, trustees, officers or other private persons, except that the corporation may pay reasonable compensation for services rendered.

The IRS also warns that if a charity gives an insider an excess benefit, such as pay well above what the work is worth, excise taxes may apply to that person and to the managers who approve it, and the IRS may still propose revoking the charity's exemption. Have the board, without you in the room, set your pay using what similar organizations pay for similar work, and record how it decided.

Other options

Keep the business and support a cause

Your business can stay a business, donate part of its profits, or partner with an existing charity. You keep ownership, and the charity gets help without a new organization. Our guide on earned income covers how charities and businesses can work together.

Fiscal sponsorship

If the project, not the business, is what you want to turn charitable, a fiscal sponsor (an existing charity that takes your project under its wing) can let you accept tax-deductible donations without forming your own nonprofit. See fiscal sponsorship.

A benefit corporation

Some states allow a benefit corporation: a for-profit business corporation that commits to public benefit alongside profit. New York's Business Corporation Law, for example, defines a benefit corporation as a business corporation incorporated under its benefit corporation article, and says every benefit corporation must have a purpose of creating "general public benefit." It defines that as a material positive impact on society and the environment, taken as a whole, assessed against a third-party standard.

A benefit corporation is still a business corporation, not a charity. Under the IRS rules above, a 501(c)(3) can't let its earnings benefit private owners, so a business run for its owners can't be one. A benefit corporation can be a good fit if you want to keep ownership and build in a social mission.

Before you decide: checklist

• Write down who would own, govern and benefit from each option
• Accept that a nonprofit has no owners and its assets stay charitable
• Check your state's rules on forming a nonprofit corporation
• List any assets the charity would take over, and how you'd value them
• Plan to complete Schedule G of Form 1023 as a successor
• Have the board set any founder pay as reasonable compensation
• Compare fiscal sponsorship and a benefit corporation before you file anything