Converting Your Business Into a Nonprofit
"My wife and I have been running a for-profit service business for the past 10 years.
"We have recently learned that our business may qualify as a nonprofit organization, as we frequently provide our services for free or at an extremely low cost to people who can't afford them.
"We're looking to retire shortly and think it would be fun to continue running the business strictly as a nonprofit. What is the best way to do this?"
Before we get to the legal stuff, there are a few things you need to consider before you go the nonprofit route.
First, keep in mind that when you run a nonprofit organization, you are no longer an owner of the business, and you will not be entitled to a share of the business' profits as you are currently. All profits from a nonprofit's operations must be devoted to the organization's tax-exempt mission.
As directors of the nonprofit, you are entitled to reasonable compensation, but this won't be very much. If the nonprofit is making more than $50,000 a year in donations, you may be required to have your annual compensation approved by independent directors who aren't involved in day-to-day operations, and they won't be easy to find or deal with (for example, they may want you to buy liability insurance for them).
Second, there are only three ways a nonprofit can generate a tax-exempt income: donations (which are tax-deductible to the donor if you qualify as a public charity under Section 501c3 of the Internal Revenue Code), government grants and fundraising activities.
If you charge a fee for the services that you are providing folks in a nonprofit, those services must be "reasonably related" to your organization's tax-exempt purpose. For example, an organization set up to provide care services for the elderly can charge a small fee (below market) for wheelchairs or have its out-of-pocket expenses reimbursed.
Income from services that are unrelated to the organization's tax-exempt purpose is considered unrelated business income by the IRS; it does not affect your tax-exempt status, but you must pay tax on the "unrelated business income" just the same as if you were a for-profit business (for more information, visit the Unrelated Business Income Tax page on the IRS's website). An exempt organization with more than $1,000 in unrelated business income must file an IRS Form 990-T each year. An organization must pay an estimated tax using the IRS Form 990-W if it expects its unrelated business income tax for the year will be $500 or more.
You need to have a long chat with your accountant to make sure none of the above will be problematic for you before you decide to pursue the nonprofit path.