If you’ve been operating a business as a Limited Liability Company (LLC) and you’re thinking about converting to a nonprofit, there are certain steps you’ll need to take to accomplish that.
It varies depending on your state, but in many cases, you won’t be allowed to directly convert an LLC to a nonprofit. Instead, you’ll need to follow the rules of your state to dissolve the LLC and then start a new nonprofit organization. Some states, however, do permit a conversion, so I’ll tell you about that process, as well.
Before we take a deeper dive into changing your LLC to a nonprofit organization, however, let’s go over the basics of nonprofits and how they’re different than LLCs and other for-profit businesses.
Understanding the Basic Elements of a Nonprofit
People tend to lump nonprofits into a single category, but the truth is there are many varieties of this type of business entity operating in a wide swath of fields including health care, education, the arts, human services, religious, scientific, animal welfare, and others.
Some traits shared by all nonprofit organizations are that they are public entities that do not operate with the primary purpose of generating a profit. Any money they generate – known as surplus revenues – are reinvested back into their operations to support the mission of the organization.
Nonprofits don’t have owners but are governed by a board of directors responsible for making major decisions based on the organization’s stated purposes. An executive director normally is appointed to oversee day-to-day operations of a nonprofit.
A nonprofit organized at the state level is known as a Nonprofit Corporation. Registering at the state level may provide some benefits, such as exemptions from state sales tax, property tax, and income tax.
A Nonprofit Corporation does not automatically qualify for federal tax exemptions, though. To enjoy that status, a nonprofit must meet certain eligibility requirements under Section 501(c) of the IRS Tax Code.
The 501(c) tax category that’s most familiar to many people is 501(c)(3) status, as it covers the types of nonprofits most people know and contribute to. To receive a 501(c)(3) classification from the IRS, an organization must be considered “charitable” and be established for one of the following causes:
- Charitable
- Religious
- Educational
- Scientific
- Literary
- Testing for public safety
- Fostering of national or international amateur sports
- Prevention of cruelty to children or animals
A 501(c)(3) organization can be a charitable organization or a private foundation that is considered charitable. While charitable organizations typically are funded by members of the general public who support their goals, private foundations often receive financial support from a single source, such as a family or a Corporation. Private foundations normally distribute funds to other charitable organizations instead of operating programs themselves.
An organization that has 501(c)(3) status is exempt from paying federal taxes and is allowed to collect tax-deductible donations from individuals and businesses and receive grant money.
While 501(c)(3) is the most common tax status for nonprofits, the 501(c) designation has been widened over time to include entities other than charitable organizations and private foundations. The IRS has a long list of types of nonprofits that can qualify for some 501(c) designation, such as agricultural organizations that can enjoy 501(c)(5) status or business leagues that may be designated as 501(c)(6) organizations.
Before you consider changing your LLC to a nonprofit, I’d highly recommend that you do some research to see whether your organization meets, or would be able to meet, the qualifications for 501(c) status from the IRS.
Differences Between an LLC and a Nonprofit
While the primary purpose of a public nonprofit is to generate funds to reinvest back into their operations to support the mission of the organization, an LLC is a private company that operates for the purpose of generating a profit for its owner or owners, called members.
Nonprofits rely on grants, contributions, and fundraising for revenue, while LLCS generate revenue through sales of the goods or services it offers.
Unlike a nonprofit, the owners of an LLC get to decide how the company is managed, how it is taxed, and how it will be run, depending on the provisions of its Operating Agreement.
And while a nonprofit that meets specific criteria may qualify for tax-exempt status under U.S. law, the IRS is quick to tax profits generated by LLCs.
Those profits are by default subject to pass-through taxation, meaning they are passed through to the individual tax returns of owners, who pay taxes based on their individual tax rates. The business itself does not pay taxes unless it elects to be taxed as a Corporation, which is taxed at a corporate level with owners’ income also taxed at a personal level.
Why An LLC Might Want to Convert to a Nonprofit
There are a number of reasons why members might consider changing their business entity from an LLC to a nonprofit.
It’s not unusual for an entity to form as a for-profit business, only to have its owners realize months or years later that their mission is better suited to that of a nonprofit. They might conclude that operating as a nonprofit would enhance their credibility as an organization and generate good will among potential supporters.
Other business owners may be drawn to a nonprofit because of its potential for eligibility for federal and state income tax exemptions, or because they want to be able to apply for grants and attract donations from individuals and other businesses.
Like an LLC, a nonprofit organization provides limited liability protection to those associated with it, protecting them from personal liability if the organization can’t repay debt or in facing a lawsuit. And many founders of nonprofits appreciate knowing that the organization can be passed along to family members or other like-minded people who can continue their good work.
Whatever your reasons are for wanting to convert your LLC to a nonprofit, you also should be aware of some potential disadvantages of doing so.
Potential Downsides of Operating a Nonprofit
As I’ve mentioned, a nonprofit is governed by a board of directors that is responsible for important decisions regarding the organization and its assets. As founder of the nonprofit, you could end up having little say about its business operations.
While that might sound discouraging, it underscores the importance of carefully choosing people to serve as board members, making sure that their goals and values align with yours and other founders.
If you plan to operate as a 501(c)(3) organization, you’ll have to meet some very specific requirements to achieve that designation. As noted previously, any profits must be reinvested into the work and mission of the organization. You’ll need to confirm the ways in which you’re serving the public good and refrain from participating in certain political activities.
You also should be aware that nonprofits are held to high standards when it comes to legal and tax compliance issues. Organizations that enjoy tax-exempt status must be very diligent about meeting all the requirements necessary to maintain that status.
If you feel that your business is better suited to a nonprofit than an LLC or other for-profit business entity, however, it’s likely that you’re willing to deal with any potential downsides and move forward to achieve your mission and goals. Just be aware of all requirements and remain proactive about addressing them.
Two Options for Converting an LLC to a Nonprofit
As you read earlier, many states do not allow for the direct conversion of an LLC into a nonprofit, requiring you instead to dissolve the LLC and start a new business. You’ll need to do some research to determine the laws of your state and decide how to proceed.
If your state does allow for statutory conversion, you’ll simply file some paperwork to change the legal structure of the business. If you’re not able to convert it to a different legal structure, you’ll need to take some extra steps. Let’s have a look at each of these methods, starting with dissolving an LLC and registering a new nonprofit.
Option 1. Dissolve the LLC and Register a Nonprofit
If you must dissolve the LLC and restart it as a nonprofit by registering it with the state, there are actions you should take to assure the process is completed properly. In this section, I’ll walk you through some steps for dissolving a business as well as those for getting your nonprofit set up and registered.
Hopefully, your LLC’s Operating Agreement lays out the steps for its dissolution. If it does not, you’ll need to follow your state’s laws pertaining to LLCs.
Typically, the following steps are necessary when dissolving an LLC:
- Hold a meeting for all members to vote on the dissolution, making sure that minutes are taken and the vote of each member recorded.
- Following the vote, have each member sign a formal document acknowledging the dissolution.
- Give each member a copy of the document and file the original in a safe place.
- File Articles of Dissolution or a similar document with your state. Doing that signals that the LLC must cease all regular business and begin the process of winding up its affairs.
- Begin winding up affairs by settling all business debts and paying any creditors, such as suppliers.
- Close any bank accounts that aren’t needed to pay bills.
- Pay all taxes owned and file final tax returns and reports.
- Cancel all business licenses and permits.
- Close out any assumed names you may have used for the LLC.
- Withdraw the business from any states in which you were registered as a Foreign LLC.
Once you’ve dissolved the LLC, you can take steps to register your nonprofit with the state.
Before moving ahead with registering your nonprofit, take some time to review your ideas and plans to make sure they are viable and will allow you to move forward.
Start by assessing the needs of the community your nonprofit will serve. Get input from those who will be served by the nonprofit and from the individuals and businesses you hope will support it. Consider your startup and ongoing costs, anticipated income needs, possible sources of income, and other factors before committing substantial time and resources to a business launch.
Once you’ve determined the feasibility of the nonprofit, you’ll want to draft a mission statement that captures its purpose, who the organization will serve, and how. You’ll also want to get a good business plan in place to serve as a roadmap for your organization.
If you want to use your LLC’s name for the nonprofit, it’s likely you can do so as most states allow for names of dissolved businesses to be reused. If, however, you choose to retain the name of your business, make sure it reflects the purpose and goals of the nonprofit.
Key steps to register your new nonprofit:
- Select the legal structure for your nonprofit. Depending on your state, you may be able to form the nonprofit as a Nonprofit Corporation, Nonprofit LLC, Unincorporated Nonprofit, or a trust. Most nonprofits register with the state as a Nonprofit Corporation and then apply for 501(c)(3) status from the IRS.
- Recruit and appoint a board of directors, naming board members who share your goals and values. Most states require nonprofit organizations to have at least three members on their boards. Ideally, you’ll get board members in place early in the process of forming your nonprofit, as they are legally accountable for the incorporation of the organization.
- Get your nonprofit bylaws in place that outline how the nonprofit will operate.
- Obtain an Employer Identification Number (EIN) so you can open bank accounts in the name of the nonprofit. You EIN also will be tied to your tax-exempt status with the IRS.
- File Articles of Incorporation with the Secretary of State’s office, paying any associated fees. If the nonprofit will have physical locations or a substantial presence in more than one state, it will need to be registered in each of those states, as well.
- If you plan to accept donations or participate in fundraising activities, check with the state to see if Charitable Solicitation Registration is required. Nonprofits often complete this application when filing Articles of Incorporation.
- Transfer any remaining assets of the LLC to the nonprofit, a step that may require the approval of the board of directors. Make sure to get a written agreement in place that states the details and terms of the transfer.
Once you’ve completed these steps, you can file with the IRS for 501(c)(3) or other 501(c) status.
Option 2. Convert Your LLC to a Nonprofit
If your state is one that allows for a statutory conversion, you could choose that route instead of dissolving the LLC and starting a new nonprofit. Statutory conversion is the most direct method of making that change.
To do so, you’ll need to file paperwork with your state detailing your reasons for wanting to convert your LLC to a nonprofit organization. Often called Articles of Conversion, the paperwork will include your nonprofit’s goals and mission and explain how LLC owners came to the decision to make the change. You also may have to provide financial information regarding taxes and debts owed by the LLC. If you need help filing Articles of Conversion, an expert at CorpNet can guide you through the process and answer all your questions.
If you’re going to apply for 501(c)(3) status with the IRS, you’ll have to change your LLC to a Corporation to satisfy the regulation that all 501(c)(3) organizations must be incorporated by filing Articles of Incorporation with your state.
Make sure you’ve satisfied all state requirements, such as appointing a registered agent and obtaining an EIN. You’ll need to create Corporate Bylaws and pay attention to identifying people to serve on your board of directors.
It’s important to understand all the requirements of your state and follow instructions for meeting them. You’ll also need to apply for federal tax-exempt status from the IRS, which is a separate process from the state-level conversion.
CorpNet Can Help You Convert to a Nonprofit
CorpNet can help you convert your business from its current entity type to another. We’re here to assist you every step of the way in preparing and filing the required documents!
Filing for 501(c)(3) Status With the IRS
Applying for 501(c)(3) status is one of the most important tasks you’ll undertake when starting a nonprofit organization, as you need the status (or another 501(c) status) to operate as a tax-exempt organization.
Having 501(c)(3) status also may enable an organization to claim income and property tax exemptions and provide access to grant money. Also, people donating to a 501(c)(3) organization may claim the donations as tax deductions, which can increase the likelihood of your organization attracting donors. While it’s possible your nonprofit is better suited for another 501(c) designation, for now we’ll focus on filing for 501(c)(3) status, as it’s the most common type of 501(c) organization.
While applying for this status occurs relatively late in the process of forming your nonprofit, you should be confident before doing so that you’ll be approved as a tax-exempt organization by the IRS. You can do this by making sure you meet the IRS regulations of operating with a specific purpose, whether it is educational, scientific, charitable, religious, or literary. You also must be able to demonstrate that your organization was formed to serve the good of the public.
The IRS allows you to apply for 501(c)(3) status before incorporating the nonprofit, but most organizations wait until they’ve completed that process and have a board of directors in place, as it typically makes the process proceed more smoothly.
Apply using IRS Form 1023, or, for smaller organizations that meet certain criteria, Form 1023-EZ. The EZ form is more streamlined and has a lower application fee than the standard form. Both forms require you to provide detailed information about the purpose of your nonprofit, the activities it engages in, and who it serves.
You’ll need to prove that your mission is in line with IRS requirements and provide the names of your board members, along with key documents such as your Articles of Incorporation, Corporate bylaws, and a conflict-of-interest policy.
In addition to filing for tax exemption at the federal level, some states require you to register your nonprofit and apply for tax exemption at the state level. Check with your Secretary of State’s office to see if it’s necessary to do so in your state.
Once you’ve filed the application, the IRS will contact you if it needs additional information. If you’re approved, you’ll be notified by mail, but you can check on your application on the Tax Exempt Organization Search page of the IRS website. Applying for and obtaining 501(c)(3) status can be a cumbersome process. If you’re feeling overwhelmed by the task, a professional at CorpNet can help.
CorpNet Can Help You Apply for 501(c)(3) Status
CorpNet can help you start your new nonprofit quickly and efficiently by completing and submitting all the IRS 501(c)(3) and state forms for you!
Keep Your Nonprofit in Compliance
As I mentioned earlier, nonprofits are held to high compliance standards by the government. You’ll need to make sure that you understand all state requirements that apply to your organization and be diligent about filing all the required paperwork. You’ll also need to maintain accurate records for tax purposes and make sure to file on time to avoid IRS scrutiny that could cause problems for your nonprofit. Most 501(c)(3) organizations must file IRS Form 990 every year, providing information about revenue, expenses, governance, liability, programs, and activities. You may also be required to file annual reports with your state.
Many nonprofit organizations hold events to raise awareness and generate funds, but it’s important to know what you must do to register for such events and how to secure the necessary licenses and permits. Look for state guidance and pay attention to any local regulations.
Forming and operating a nonprofit are noble causes, but as with any business, require a lot of effort and diligence to make sure the business is set up and operated properly. Changing a business from an LLC to a nonprofit adds another layer of complexity, so don’t hesitate to consult a professional if you need help.
Want to Learn More?
Below is a list of additional articles covering nonprofits:
