All For One, and One For All
Joint Ventures Can Benefit Nonprofits
Not-For-Profit Advisor, 2006 Winter
At some time in its life cycle, a nonprofit organization may want to participate in a joint venture. Joint ventures can help to expand or diversify a nonprofit’s activities and raise capital beyond charitable giving. By joining with a for-profit partner, an organization could bring valuable business expertise to the venture.
Before jumping into this kind of partnership, be sure you know exactly what you expect to gain. If you don’t give the project proper forethought, you could face unwelcome surprises.
Structure Correctly
One of the primary decisions an exempt entity must make when approaching a joint venture is the legal structure under which it will operate. The most common choices are partnerships, limited liability companies, joint ventures, or subsidiaries.
The first three are options to consider when jointly participating with an outside party, usually a forprofit company. A subsidiary is used more often when the tax-exempt entity wishes to expand its activities within its own structure.
Consider Tax Issues
The two main tax considerations in joint ventures are maintaining your tax-exempt status and evaluating whether unrelated business income applies.
Generally, an exempt entity that participates in any type of partnership or joint venture structure must retain sufficient control to ensure that its exempt purpose is fulfilled. Otherwise, the organization could lose its exempt status. The IRS has developed a two-pronged test to determine exempt-status jeopardy:
- The charitable purpose of the exempt entity must be served.
- The structure must insulate the exempt organization so that it does not place the exempt organization’s assets at risk. (Private benefit to individuals or other organizations isn’t permitted.)
Tax rulings and court cases stress the importance of the degree of control exercised by the exempt entities. Revenue Ruling 98-15 outlines basic considerations in determining control questions.
This ruling states that the organizing documents should contain a structure providing the exempt entity with control over the venture. It also says that the IRS will look favorably on any provisions in governing documents that require the venture to give charitable purposes priority over maximizing profits (through such provisions as voting control). Additionally, the ruling also states that the IRS will scrutinize provisions made in the organizing documents that effectively limit the exempt entity’s control.
In Redlands Surgical Services v. Commissioner (1999) 113 TC 47, the Tax Court emphasized the importance of the control issue in determining whether the exempt status of the organization had
been impaired.
Your organization should be particularly cautious when involving itself in a limited partnership. If the limited partners are insulated to risk while the general partner (the exempt entity) has an increased potential of risk, this could ultimately cause private benefit to the limited partners. This private benefit could result in a loss of the organization’s exempt status.
Beware of UBI
Beyond the exemption issue, the tax-exempt entity also must determine whether the joint venture creates unrelated business income (UBI). The exempt organization will be subject to unrelated business income tax on any activity that is unrelated to its exempt purpose. Even joint ventures involving only exempt organizations must further the exempt purposes of all the entities involved in order for the income not to be taxed.
To gauge whether the joint venture income is UBI, the entity must determine that the income is from a trade or business that is regularly carried on and that isn’t substantially related to the entity’s exempt purpose. If the activity meets these criteria, then it creates UBI, which is taxable.
Create A Subsidiary
Creating a subsidiary might be advisable under several circumstances. These include the following:
- Unrelated activities becoming too extensive to remain in the current nonprofit entity
- Parent organization wanting insulation from liability for certain activities or ownership of property
- Organization desiring more simplified record keeping
- Organization wanting to protect confidential aspects of unrelated activities
Most commonly, an organization will create a subsidiary when its
increasing unrelated activities may jeopardize its tax-exempt status. Although tax laws don’t draw a clear line indicating
when unrelated activities jeopardize the exempt status,
the courts have provided some guidance.
In one case, the court found that less than 10 percent of unrelated activity didn’t impede the exempt status. In another case, an organization that received one-third of its income from unrelated activities was forced to forfeit its status.
Choose Carefully
Joint ventures and the formation of subsidiaries are becoming much more common for exempt entities as their activities become more complex. With proper planning, you can implement an appropriate structure to avoid both tax problems and terminating your exempt status.