Can a 501(c)(3) Organization Change Into a 501(c)(4) Organization?

Is it possible for a 501(c)(3) organization to change into a 501(c)(4) organization? The short answer is no (Revenue Procedure 2017-5). But it may be possible for a 501(c)(3) organization to cause the creation of a 501(c)(4) organization and subsequently dissolve, leaving only the 501(c)(4) organization. This strategy has its own complications as we describe below. Before we get to that …

Why Would a 501(c)(3) Organization Want to Change Into a 501(c)(4) Organization?

Many people believe that it’s far more advantageous to be a 501(c)(3) charitable organization rather than a 501(c)(4) social welfare organization because only 501(c)(3) organizations qualify to receive deductible charitable contributions.* But 501(c)(4) organizations have more freedom to engage in activities that 501(c)(3) organizations either can’t engage in or can only engage in to a limited degree. For example, a 501(c)(4) organization can spend all of its money on lobbying so long as the lobbying is in furtherance of its social welfare mission. Further, a 501(c)(4) organization can spend its money and use its resources to fund political campaigns and candidates (electioneering) so long as such activity doesn’t constitute its primary activity. In contrast, a public charity can engage in only limited lobbying activities (though there are relatively generous limits, particularly for a charity making the 501(h) election), and a private foundation is prohibited from lobbying (though there are ways for a foundation to support charities that engage in lobbying). All 501(c)(3) organizations are absolutely prohibited from electioneering. For more information about the differences, see Comparing 501(c)(3) vs. 501(c)(4) for Nonprofit Startups. In addition, earlier this week, the Treasury Department announced a change in the regulations making it no longer necessary for a 501(c)(4) organization to disclose the identities of its donors on its annual information returns to the IRS. 501(c)(3) organizations remain subject to the disclosure requirement. This makes it easier for donors to 501(c)(4) organizations to contribute anonymously for electioneering purposes (dark money). See Treasury Eliminates Donor Information Disclosures by 501(c)(4) and 501(c)(6) Organizations.

So, for a 501(c)(3) organization that believes it may better advance its mission by engaging in more lobbying than is permitted and/or some electioneering, the 501(c)(4) option might be worth considering. The organization would then need to factor how detrimental the inability to receive deductible charitable contributions would be on its mission. Prior to 2018, this might end the discussion or at least change it to the consideration of forming an affiliated 501(c)(4) organization and running both a 501(c)(3) and a 501(3)(4) organization with some level of coordination. See When Should a 501(c)(3) Consider Creating an Affiliated 501(c)(4)? But once the Tax Cuts and Jobs Act became effective, it meant that only 5-10 percent of taxpayers would be able to get a tax benefit from making a charitable contribution due to the rise in the standard deduction, and that is expected to reduce annual charitable giving by $16-17 billion (see New Tax Study Anticipates Significant Decrease in Charitable Giving Following Tax Reform, AFP). Accordingly, it seems that it may not be as a big disadvantage to fundraise as a 501(c)(4) organization than it once was, particularly, for some organizations, if they can show to the their donors that they can exercise greater impact on bad legislation and putting people in power who share their values. See A prediction for nonprofits in 2018: Rise of the 501(c)(4) organizations; GOP’s new tax law encourages campaign donor secrecy (The Hill).

* FN for tax nerds: The deductibility of a charitable contribution is actually described in IRC §170, and entities eligible to receive deductible charitable contributions are described in IRC §170(c). There is substantial, but not complete, overlap between 170(c)(2) and 501(c)(3), the most important difference being that foreign organizations do not qualify to receive deductible charitable contributions under 170(c)(2) even though they may be exempt under 501(c)(3).

Revenue Procedure 2017-5

Section 3.02 of Rev. Proc. 2017-5 provides that the Service will ordinarily not issue a determination letter in response to any request if—

an organization currently recognized as described in § 501(c)(3) seeks a determination letter recognizing the organization as described in a different subsection of § 501(c). An organization currently recognized as described in § 501(c)(3) may seek a determination letter under a different subsection of § 501(c) once it has dissolved and re-formed as a new entity.

So, a 501(c)(3) organization would ordinarily need to dissolve and a new organization would need to be formed as a 501(c)(4) organization. But there’s a problem with that …

501(c)(3) Organizational Test

In order to qualify as tax-exempt under Section 501(c)(3) of the Internal Revenue Code (IRC), an organization must pass an organizational test codified in the Treasury Regulations. Generally, the organizational test requires that the organization’s articles of organization (e.g., articles of incorporation, certificate of incorporation, trust instrument):

  1. Limit the organization’s purposes to one or more exempt purposes described in 501(c)(3) (e.g., charitable, educational, religious, scientific);
  2. Do not expressly empower the organization to engage, otherwise than as an insubstantial part of its activities, in activities which in themselves are not in furtherance of one or more 501(c)(3) exempt purposes; and
  3. Evidence that its assets are dedicated to one or more 501(c)(3) exempt purposes, including requiring that its assets, upon dissolution, be distributed for one or more exempt purposes, or to the Federal Government, or to a State or local government, for a public purpose, or would be distributed by a court to another organization to be used in such manner as in the judgment of the court will best accomplish the general purposes for which the dissolved organization was organized.

The dissolution clause above may not be required if the organization’s state of formation has a law that imposes the same requirement upon the organization.

It’s very common for organizations to adopt a dissolution clause that is more limiting than required under the organizational test. Instead of merely dedicating remaining assets to one or more 501(c)(3) purposes, the clause dedicates them to one or more 501(c)(3) organizations. For example, the dissolution clause in the sample form articles of incorporation provided by the California Secretary of State provides as follows:

Upon the dissolution or winding up of this corporation, its assets remaining after payment, or provision for payment, of all debts and liabilities of this corporation shall be distributed to a nonprofit fund, foundation or corporation which is organized and operated exclusively for charitable, educational and/or religious purposes and which has established its tax-exempt status under Internal Revenue Code section 501(c)(3).

Such a dissolution clause would prevent a 501(c)(3) organization from dissolving and distributing its remaining assets to a new 501(c)(4) organization that had been organized to take its predecessor’s place.

Grants to a 501(c)(4) Organization

While a 501(c)(3) organization may be prohibited from distributing its remaining assets upon dissolution to a 501(c)(4) organization, it can make a grant to a 501(c)(4) organization. Whether a grant to an affiliated 501(c)(4) organization intended to be the successor of the 501(c)(3) organization grantor is skirting the organization’s dissolution clause or the need for approval of a state regulator (e.g., Attorney General) would best be reviewed by an attorney well-versed in this area.

In addition to the dissolution clause and state regulator issues, a 501(c)(3) organization’s grant to a 501(c)(4) organization comes with restrictions on how the granted funds and/or assets can be used. Generally, the grant must not be used to fund activities that would be impermissible to the 501(c)(3) organization. Accordingly, it should be made pursuant to a written grant agreement that clearly requires the funds to be used solely for 501(c)(3)-consistent purposes and explicitly restricted from use in electioneering. A general operating grant would not be permissible, even for startup costs. Further, a public charity’s grant made for the stated purpose of supporting the 501(c)(4)’s lobbying activities must be accounted for as a lobbying activity and/or expenditure of the charity; even a grant that is silent on its potential use for lobbying may be attributed as a lobbying expenditure by the charity under certain circumstances. See Lobbying & Grants to Non-501(c)(3) Entities: Know The Rules. This gets more complicated if a private foundation is making the grant to a 501(c)(4) organization as a private foundation, unlike a public charity, is prohibited from lobbying and must exercise expenditure responsibility in making such grants. See Grants to noncharitable organizations (IRS).