Making the Switch: Converting Your Nonprofit Into a For-Profit
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Gain a better understanding of the process of transitioning a nonprofit to for-profit and protect the nonprofit from significant liabilities.Nonprofit organizations operate under intense public scrutiny. No activity is subject to more scrutiny than a nonprofit organization's conversion into a for-profit organization. Conversions must be carefully approached and structured with an eye towards how the IRS, Attorney General and/or the public at large will perceive them.There is little room for error. This topic delivers a crash course for persons tasked with advising a nonprofit whether and how to convert into a for-profit. We will walk through the relevant legal backdrop, various methods for converting, as well as common pitfalls and traps for the unwary. Failure to properly approach and consummate such conversions can result in significant liabilities including, but not limited to, retroactive revocation of exempt status, expensive Attorney General and/or IRS investigations and excise taxes against the fiduciaries and individuals approving the conversions. This topic will ensure nonprofits and their advisors approach conversions with their eyes wide open and are able to utilize various prophylactic measures to protect them.
AuthorsJohn Paul Callahan, Reid & Riege, P.C. Edward B. Spinella, Reid & Riege, P.C.
• "Definition of Nonprofit": A Common Misnomer
• "Tax-Exempt" (Presuming Pursuant to 501(C)(3) of the Internal Revenue Code)
- 501(C)(3) of the Internal Revenue Code: The Organizational and Operational Tests
- Who Owns a Nonprofit?
- Private Benefit Doctrine
- Intermediate Sanctions: Excess Benefit Transactions and the Rebuttable Presumption of Reasonableness Safe Harbor
• Donor Restricted Assets
• Who's Watching?
- The IRS, the Attorney General, the Public
- The Courts?
• Excessive Commercial Activity (Unrelated Business Income)
• Succession Planning
• Onerous Operational Rules and Governance Scrutiny (Too Much Transparency?)
How Do You Convert?
• State and Federal Law Components That Need to Be Harmonized
• State Law
- 1) Form and Procedure
- 2) Interplay Between Nonprofit and For-Profit Acts
- 3) Corporate Document Amendment
- 4) Model Entity Transactions Act - Conversion (Many States Exclude "Nonprofits")
- 5) Asset Sale (in Connection With Liquidation?)
- 6) Merger
- 7) Attorney General Disclosure and/or Approval?
• Federal Law
- 1) De-Recognition of Tax Exempt Status? Revisiting the Organizational and Operational Test
- 2) Default Status: Taxable Nonprofit
- 3) Remaining Basis for Tax Exempt Status and New Determination Letter?
- 4) Fair Market Value. Independent and Qualified Valuation(s).
- 5) IRS Disclosure
• Conflict Between State and Federal Law
• No Legitimate Reason to Explore in Furtherance of the Nonprofit's Purpose
• Inadequate Documentation of Prudent and Arms-Length Due Diligence and Deliberation
• Insignificant Due Diligence
• Ignoring Tax Ramifications (Not Just Income Tax)
• "Counsel to the Deal"
• The "Goodwill" and "Public Perception" Factor
• Termination of Private Foundation Status