It is not uncommon for a nonprofit to create affiliate organizations in order to expand its reach into new areas, protect critical assets, or engage in activities that may otherwise jeopardize the exempt status of the parent nonprofit. For example, among the restrictions placed on 501(c)(3) nonprofits are strict limits on their political activities. Certain types of political speech can cause a 501(c)(3) to lose its federal tax status, exposing the organization to income taxes and potentially invalidating the tax-exempt status of donors’ gifts.
One remedy is to establish a separate affiliate to house the group’s political activities. Following such a strategy allows a 501(c)(3) to continue receiving tax-deductible donations while providing support to its affiliate’s political activities. This approach requires care to preserve the separation of the two entities and avoid jeopardizing the parent nonprofit’s status.
Corporate structure and governance
Nonprofit affiliates must be structured as separate legal entities and can be set up as either an LLC or nonprofit corporation. As a separate legal entity, a nonprofit affiliate should have its own bylaws, board of directors, meetings, financial accounts, records, annual reports, and tax filings. While the parent nonprofit may still exercise control over the affiliate through an affiliation agreement, it must not directly manage the daily activities of the affiliate.
There are some areas where overlap may occur as long as the parent nonprofit remains vigilant about maintaining a hands-off approach to the affiliate’s daily business. The nonprofit and the affiliate may share specific resources, such as board members or even officers although it is advisable that individuals do not fill the same role for both organizations.
Avoidance of improper subsidies
To protect its nonprofit status, a charitable organization must refrain from improperly subsidizing an affiliate. Since a nonprofit’s source of funding is often comprised of donations that are deductible as charitable contributions, its funds cannot be used to promote the activities of its non-charitable affiliate. Non-charitable affiliates may not derive excessive financial benefits from a parent nonprofit or they could face significant penalties from the IRS.
However, sometimes it makes more sense for certain resources — employees, office space, mailing lists, and even intellectual property — to be shared between the nonprofit and its affiliate. This can be accomplished via a formal written resource-sharing agreement. Each shared resource must be priced at fair market value to avoid the appearance of an improper subsidy.
The process of establishing nonprofit affiliates is quite involved and needs to be handled with an attorney’s assistance. The Church Law Center of California counsels churches and secular nonprofits. We are happy to help your organization evaluate its options, whether that means forming an affiliate entity or transferring a 501(c)(3)’s assets to a new nonprofit. Call us today at (949) 689-0437 or reach out to us through our contact page.