In a previous article, I already discussed some of the major differences between 501(c)(3) and 501(c)(6) organizations. However, this discussion was limited to characteristics of these organizations as opposed to dynamic developments that these organizations may experience during their existence. While most of these organizations tend to be stable once a particular type of tax-exempt organization is formed, this is not always the case. Sometimes, after a number of years in existence, an organization may modify its goals or its founders suddenly realize that they are limited in their practical options. For example, one large limitation of a 501(c)(6) organization is the inability of donors to deduct donations as charitable contributions on their tax returns. Conversely, members of a 501(c)(3) organization may desire to convert into another type of tax-exempt organization because of the substantial limitations on lobbying placed on such organizations.
At that point, a Board of Directors of such an organization may start to wonder about whether it is possible to convert the status of an organization, how to do it and whether there are any viable alternatives. In this article, I will examine the possibility of converting a non-profit organization’s tax-exempt classification, focusing on 501(c)(3) and 501(c)(6) classifications.
General Conversion Process
First, in order to attempt the conversion from one classification to another, a tax-exempt organization will need to change its organizational documents (such as the Articles of Incorporation and the corporation’s Bylaws) to reflect the primary purpose of the new type of tax-exempt organization being sought and to comply with the requirements of such organizations. Usually, the Bylaws or the Articles of Incorporation govern the exact process of approval of the amendment of these important organizational documents. Frequently, these documents will say that a Board of Directors’ resolution is sufficient, but, often, an approval of the majority of members maybe required. If the organizational documents are silent on the amendment process, your state’s statute would need to be consulted on the amendment process.
Amending the documents is usually not enough. Changing the primary purpose of an organization may also entail eliminating, or at least substantially reducing, any prohibited or limited activities under the new desired classification. For instance, if you seek to convert a 501(c)(6) organization into a new 501(c)(3) organization, then, after changing the original organizational documents (and following any necessary rules in doing so) to comply with applicable 501(c)(3) requirements, will also need to limit substantial lobbying activities and any other activities that are prohibited or limited under 501(c)(3) rules. Usually, these activities require a wholesale overview of the organization’s activities by an attorney in order to determine what types of practices need to be modified and how.
Finally, in order to convert, a new form will need to filed with the IRS requesting the grant of the new tax-exempt status, demonstrating compliance with the relevant regulations. For example, in case of conversion to 501(c)(3), Form 1023 will need to filed, demonstrating compliance with IRS 501(c)(3) rules. This, in turn, will require paying an application fee as well as providing any applicable required verification documents. There is no guarantee that the IRS will recognize the new tax-exempt status being sought. This is why it is important for the application to be well drafted, demonstrating adherence to the relevant law and regulations.
Alternatives to Conversion
The motivations for seeking alternatives to full conversion from one classification to another are numerous. Nevertheless, the most popular reason for avoiding such conversion and seeking an alternative is the fact that an outright change in classification of an entity may significantly limit the ability of such organization to achieve their goals.
It is not easy to discuss alternatives to conversion, because the particular circumstances of an organization will determine what alternatives are available and whether they are more desirable than the process of conversion.
Yet, one can identify two general trends (which may or may not apply to a particular organization), which I will state here in their ideal form. First, some organizations attempt to create a hybrid organization which contains completely separate components – one that strictly follows the rules of a 501(c)(3) and another that adheres to the 501(c)(6) rules. This alternative will require separate application forms and fees, but it may give the most flexibility to the Board of Directors (assuming the IRS grants the requested status).
On the other hand, as a second alternative, a lot of organizations opt to create a new organization altogether in order to avoid legal complications. The idea here is that the members of the Board of the old corporation will form the majority of the members of the Board of the new corporation. Beware, while this alternative may solve one type of legal complications, it may actually bring a host of others.
Conversion from one tax-exempt classification to another can be very complex and usually requires an in-depth knowledge of the Internal Revenue Code, IRS regulations and case law. Therefore, you will need to consult an experienced attorney familiar with both business and tax aspects of these issue.
If you have any questions concerning tax-exempt classifications of non-profit corporations, contact Sherayzen Law Office for legal help. Our experienced tax firm can assist you in resolving any problems in this area of law.