It’s common for business colleagues to find a shared passion outside of work, whether supporting a cause or starting a charitable organization together. But when a tax-exempt organization’s directors also hold positions at a for-profit business, hidden tax-reporting issues can arise.
In particular, there are circumstances where a tax-exempt organization, including charities and nonprofit organizations, must disclose compensation paid to its board members by their for-profit employer and, in some cases, even report that the for-profit business “controls” the charity. These disclosures appear on the charity’s annual Form 990 and often surprise people who assumed the two organizations were entirely unrelated.
What triggers that relationship? One key factor is control. If a business can hire or fire individuals who make up a majority of the charity’s board, the IRS may view the charity as being “controlled” by that business. Once that control exists, the charity must include additional information on its Form 990, such as the for-profit’s name, governance details, and in some cases, the business compensation information relating to the shared board members.
Let’s illustrate this concept with an example:
Imagine that a company, Redrock Engineering, employs three managers, Ava, Chris, and Jordan. Wanting to give back, the three start a small community charity to award scholarships to local high school students. They form a three-person board, consisting only of themselves.
Redrock has the authority to terminate all three as employees. Because the majority of the charity’s board members are Redrock employees, the IRS could view Redrock as having control over the charity, even though Redrock itself has no role in giving out scholarships.
If the charity grows large enough to file a full Form 990, it would need to disclose that it is controlled by Redrock, along with additional details about the business, including the compensation that Redrock pays to Ava, Chris, and Jordan. This may lead to salary information being disclosed to the general public.
This kind of overlap happens frequently, especially among startups or close-knit business teams launching passion projects together. What may feel like a separate side project can end up being treated as connected to the business for IRS reporting purposes. That may lead to public disclosures the founders never intended.
Fortunately, these issues can be addressed. One of the simplest solutions is to expand the charity’s board so that employees of any one company do not make up the majority. Doing so can eliminate the appearance of control and the related IRS reporting obligations.
If you are planning to form a nonprofit organization or charity, or want to ensure your existing organization does not trigger related-organization reporting requirements, our firm can help. We regularly advise clients on governance structures, IRS reporting, and relationships between businesses, charities, and nonprofit organizations.
Reach out to our office to discuss your situation before filing your next Form 990 or launching a new entity. A proactive review now can help avoid unexpected disclosures and costly or time-consuming corrections later.
