Q&A #16 – Should I take over a dormant 501(c)(3) rather than form a new organization?

Question: I am looking into forming a nonprofit organization and applying for 501(c)(3) status, but the process seems very expensive and arduous. Rather than start from scratch, I am considering taking over an inactive 501(c)(3) organization that a colleague of mine founded and has offered to let me take over. She has kept the organization’s 501(c)(3) status in good standing by filing Form 990-N every year, although the organization has been totally inactive for about 7 years. This seems like an effective way for me to save money on legal and administrative costs and get the organization started more quickly. Are there any downsides?

Answer: I have seen numerous people try this approach over the years, but it is almost always a bad idea.

The main problem is that you are going to have a very difficult time keeping the organization’s status as a 501(c)(3) “public charity” (as opposed to a “private foundation,” which is a type of 501(c)(3) organization that is subject to less favorable rules). In fact, the long-dormant organization you describe likely tipped into private foundation status years ago, since maintaining public charity status usually requires a steady flow of donations from a variety of funders.

Filing Form 990-N can conceal (but not solve) this problem, but this issue will come very much out into the open as soon as the organization’s revenue exceeds the Form 990-N annual revenue threshold of “normally $50,000 or less,” because you will be required to file Schedule A detailing the organization’s satisfaction of the “public support” tests.

Planning Tip – When forming a new organization and applying for 501(c)(3) status, you can choose to have the organization deemed to be a public charity for its first 5 tax years. This option provides much-needed time to build your base of “public support” so that you can be in a position to satisfy these important tests starting in year 6 (based on 5 years of aggregate data).

Additionally, while taking over a dormant 501(c)(3) organization can, in theory, get you a quick path to having a 501(c)(3) approval letter, there would be little substance supporting the letter. If your organization’s new mission and activities are significantly different from those described in the prior organization’s Form 1023, the letter won’t be binding on the IRS. In the event of an audit, you may end up needing to prove to the IRS that the organization still qualifies for 501(c)(3) status.

Lastly, you may find that this approach you will not save as much time or money as you think, particularly if the old organization has had other compliance failures in the past that you discover need correction (such as failure to keep up with state reporting and registration requirements).

Factoring in the need to do due diligence to make sure you are not taking over an organization with hidden liabilities, along with the time that is probably needed to revise and customize the organization’s Articles of Incorporation and Bylaws, it is often less expensive to form a new organization from scratch. And doing so will certainly provide cleaner, more transparent, and less risky results.

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