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How To Convert A Private Foundation To A Public Charity

How To Convert A Private Foundation To A Public Charity

So, you started a private foundation.  But now that the IRS has approved your nonprofit as a foundation, you’re questioning whether or not that was the right idea.  You’re thinking maybe you should have chosen public charity.  Surely you can get the IRS to change that designation, right?  The good news is, yes, you can change it.  The bad news?  This is going to take a while.

Changing from Public Charity to Private Foundation

Needing to change 501(c)(3) classification is a common occurrence.  And the primary purpose of this article is to talk about converting from private foundation to public charity.  Before we jump into that, however, I think it will help you, the reader, to compare the reverse.

Sometimes it’s a public charity that, somewhere along its life cycle, the board and/or membership determines that a being classified as a private foundation is more appropriate.  If so, there are multiple ways to achieve that.

First, the more formal approach is to file IRS Form 8940 and request the reclassification from public charity to private foundation.  There really aren’t any pre-qualifications required to make this request.

The less formal approach is to simply stop filing your customary version of IRS Form 990/990EZ/990-N, and start filing Form 990-PF.  The PF version of Form 990 is exclusively for private foundations.  If a public charity files Form 990-PF, the IRS will consider that to effectively be the equivalent of filing Form 8940 and making a formal request.

The net result of either process is the near immediate reclassification of your public charity into a private foundation.

Changing from Private Foundation to a Public Charity

Given how straightforward that process sounds, it stands to reason that changing from a private foundation to a public charity would just as easy, right? Stop filing Form 990-PF and start filing one of the 990s appropriate for a public charity?  Unfortunately, it’s not quite that simple.

The reason changing from a public charity to a private foundation is fairly easy is that it is essentially a downgrade. Now by that, I don’t mean that a private foundation is in any way inferior. It’s not. But, because it is more restricted as to donation deductibility and subject to tighter rules on self-dealing, it’s like saying you’re voluntarily agreeing to more scrutiny. As a result, the IRS allows for an instant changeover.

But let’s look at what’s implied when changing from a private foundation to a public charity. In making this request, the nonprofit is asking the IRS for essentially an upgrade: higher donation deductibility and less restrictions on insiders, especially if those insiders want to get paid for working for the charity. As a result, the IRS is much less accommodating, and in fact makes it pretty tough. How tough? It’s a process that will take you 5 years to finish!

Form 8940 And The 60 Month Walkout

It begins by making the initial request on IRS Form 8940, informing the IRS of your intent to change from an approved private foundation 501(c)(3) to a public charity 501(c)(3). But that’s only the beginning. The filing of Form 8940 begins a 60-month countdown, during which time your nonprofit is expected not only to conduct itself as a public charity when it comes to actions and programs, but also with regard to income issues, such as the public support test.

So what’s significant about the 60 months? It has everything to do with that public support test.

The public support test is calculated based on a 5 year, or 60-month, average. The IRS never looks at one year in isolation to see if a public charity has sufficiently broad donor support. In fact, a public charity isn’t required to calculate the public support test until year 6 of its existence, mainly because it doesn’t have 5 years to average together until then. Weird fact: the IRS always disregards a public charity’s 1st year when looking at the public support test.

If you have a private foundation, and you want to switch to being a public charity, the IRS expects you to walk the talk for the next 5 years until you’ve accumulated 60 months’ worth of public support to calculate a public support test AND prove that your nonprofit has indeed become a public charity, not just in word, or in deed, but in fact, provably by attracting public donor support.

Which Form 990 Do You File?

A question we are often asked is, “What kind of Form 990 do we file during that 60-month walk-out period?” It’s a logical question, and the answer is Form 990-PF. Keep in mind that you’ve only informed the IRS of your intent to convert. They haven’t granted you public charity status yet. Until they do, your nonprofit is still a private foundation, so keep filing Form 990-PF each year, remembering to check the box on page one that your nonprofit is terminating its private foundation status.

At the end of the 60-month period, you will have to file another Form 8940, just like you did before, this time bookending your walk-out, requesting final conversion of status. Unlike the prior few years, this time you’ll include the appropriate Form 990 for public charities, along with a Schedule A where you’ve calculated the public support test, proving you indeed have arrived at your goal.

An Alternative To The 60-Month Process

So, is there an alternative to the 5-year process? We get this question a lot when people find out how long it’s going to take. The answer is, yes, but it’s not always the right choice. You could start a brand new 501(c)(3) and request public charity status, with the intent to dissolve the private foundation and roll its assets and activities into the new entity. But that’s a complicated process, too. There’s a lot of compliance filings required to wind down the foundation, plus you’ll need to disclose to the IRS, and maybe the state, that you’re creating a successor organization.

It might save 2 or 3 years, but it may be more headache than help. You’ll have to decide that. It will be much more expensive, guaranteed, plus we’re talking about assembling a new board of directors, new fundraising registrations, etc. Think long and hard about what you really should do here before picking a direction.

Conclusion

There are many reasons people change from one 501(c)(3) classification to another. Changing from a private foundation to a public charity happens much more often than you would imagine, and for a variety of reasons. If this is you, Foundation Group can help you get it done. We work these scenarios all the time, so reach out if you need help. We’re here to make it easier.

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Greg McRay is the founder and CEO of The Foundation Group. He is registered with the IRS as an Enrolled Agent and specializes in 501(c)(3) and other tax exemption issues.

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