Starting and Managing a Nonprofit Organization: A Legal Guide

By Bruce R. Hopkins | Go to book overview

CHAPTER SEVENTEEN
Subsidiaries: For-Profit and
Nonprofit
It has become commonplace—and frequently essential—for a tax-exempt organization to utilize a for-profit, taxable subsidiary.The reasons include situations where
The activity to be housed in the subsidiary is an unrelated one (see Chapter 13) and is too extensive to be conducted within the tax-exempt organization.
The management of an exempt organization does not want to report the receipt of any unrelated income and so shifts it to a separate subsidiary.
The management of an exempt organization is enamored with the idea of using a for-profit subsidiary.

In most instances, the first reason is the true reason, if not the only one. An unrelated business may be operated as an activity within an exempt organization, as long as the primary purpose of the organization is to carry out one or more exempt functions (see Chapter 4). Generally, there is no fixed percentage of permissible unrelated activity—that is, unrelated business that may be engaged in by a tax-exempt organization without loss of tax exemption. (Title-holding companies have a 10 percent limit, but that limitation is too small for exempt organizations in general.) In one instance, the IRS allowed a charitable organization to remain taxexempt, even though 95 percent of its income was derived from unrelated (albeit passive) sources, because about 40 percent of the organization’s time was devoted to charitable ends.

Therefore, if a tax-exempt organization wants to engage in one or more unrelated activities and the activities will be substantial in relation to its exempt activities (e.g., constituting more than half of its total activities), the use of a for-profit subsidiary is unavoidable.

Considerations are not that much different when it comes to a nonprofit subsidiary. Usually, both entities are tax-exempt, yet the exempt functions often differ. Thus, a public charity may have a lobbying arm, or a social welfare organization or business league will have a charitable foundation. A charitable organization, however, may have a charitable subsidiary, such as a fundraising or endowment entity. Where the subsidiary is a charitable organization, it may well be a supporting organization (see discussion following and Chapter 7).

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