Recent nonprofit news highlights a trend that many lawyers are seeing more frequently in practice. Programs lose government funding. Mission-driven for-profit ventures struggle to sustain themselves financially. In response, organizations begin to ask whether operating as a tax-exempt charity might be a better fit for their work.
Examples in the news include government-adjacent programs relaunching as independent nonprofits after changes in public funding and educational or media ventures converting to nonprofit status to protect mission and public trust. These developments raise a familiar client question: should this program, or even the entire organization, become a 501(c)(3)?
The answer depends on the facts, but the option warrants careful consideration, particularly where the value of the work is primarily charitable rather than commercial.
Why organizations consider nonprofit status
Organizations typically explore conversion in three recurring situations
First, loss or reduction of government funding. Programs that were incubated within government agencies or that rely heavily on public grants may find themselves without support when budgets or priorities shift. Operating as an independent nonprofit may allow the program to continue its work, diversify funding sources, and operate with fewer political or procurement constraints.
Second, mission-driven for-profits that cannot sustain a commercial model. Educational media companies, journalism ventures, and social impact startups often discover that advertising or investor-driven revenue conflicts with mission or distorts operations. In those cases, the nonprofit form may better align governance, fundraising, and public expectations.
Third, programs embedded within larger organizations. Universities, hospitals, corporations, or fiscal sponsors may house programs with distinct charitable purposes that would benefit from independent boards, branding, and fundraising authority. A nonprofit spin-off can provide clarity and accountability.
How converting to 501(c)(3) status actually works
There is no direct conversion of a for-profit entity into a tax-exempt charity under federal tax law. In practice, conversion involves creating a new nonprofit organization and transferring or restructuring operations or converting the entity into a nonprofit corporation at the state level, and then applying for tax exempt status from the IRS and the relevant state (if applicable).
If the new nonprofit will operate as a public charity (as opposed to a private foundation) assets may be donated or sold to the nonprofit, and intellectual property may be assigned or licensed at fair market value. Contracts and employees may be transitioned, subject to applicable law and existing obligations. Where founders or insiders remain involved, private benefit and excess benefit transaction rules require particular attention. Private foundations are limited in accepting remuneration in exchange for assets by the self dealing rules.
For programs converting to 501(c)(3) status from government agencies or existing nonprofits, additional issues often arise. These include ownership of intellectual property, compliance with donor or grant restrictions, continuation of reporting obligations, and treatment of employees and benefits.
Advantages of 501(c)(3) status
Converting to 501(c)(3) status can provide access to philanthropic funding, including foundation grants, individual donations, and donor-advised fund support. Many funders will not support for-profit entities, even when the mission is charitable.
Operating as a charity can also enhance public trust. Assets are dedicated permanently to charitable purposes, and governance is overseen by a board with fiduciary duties to the mission rather than to owners or investors.
Tax considerations are another factor. A qualified charity is generally exempt from federal income tax, and state and local tax benefits may also apply. For some organizations, this reduces financial pressure and simplifies fundraising.
Disadvantages and limitations
Nonprofit status comes with significant tradeoffs. Founders and owners must give up equity and any opportunity for financial return. There is no sale value or exit comparable to a for-profit business.
Regulatory obligations increase. Charities must file annual information returns, comply with state charitable registration laws, and operate with a high degree of public transparency.
Operational flexibility may be reduced. Charities are subject to limits on lobbying and political activity, restrictions on compensation and insider transactions, and potential unrelated business income tax on certain revenue streams.
Perhaps most importantly, the decision is largely irreversible. Once assets are committed to charitable use, they generally cannot be returned to private hands.
Key questions
Before pursuing nonprofit status, counsel should examine several issues. Does the mission genuinely qualify as charitable, educational, literary, scientific, etc. under Section 501(c)(3)? Are existing revenue sources compatible with nonprofit operations? Is the organization prepared for donor restrictions and public accountability? Are founders willing to operate under nonprofit governance norms? Would a hybrid structure, such as a nonprofit with a taxable subsidiary, better serve the organization’s goals?
Conclusion
Nonprofit status is not a solution for a failing business. It can, however, be an effective restructuring tool when a program’s purpose is charitable and its long-term sustainability depends on philanthropy rather than profit.
Ellis Carter is a nonprofit lawyer with Caritas Law Group, P.C. licensed to practice in Washington and Arizona. Ellis advises nonprofit and socially responsible businesses on federal tax and fundraising regulations nationwide. Ellis also advises donors concerning major gifts. To schedule a consultation with Ellis, call 602-456-0071 or email us through our contact form.Â