Most nonprofit organizations are tax-exempt under section 501(c)(3) of the Internal Revenue Code. These organization are commonly referred to as charitable organizations. A charitable organization cannot be organized or operated for the benefit of private interests. It cannot be created for the benefit of any private shareholder or individual. Additionally, a nonprofit organization is responsible for taxes on its unrelated income (of $1,000 or more) from a trade or a business. Unrelated income is income from a trade or business that is regularly carried on and not substantially related to the charitable, education, or other purpose that is the basis of the organization’s exemption.
As you can see, there are several restrictions that a nonprofit must follow in order to keep its tax-exempt status. However, a nonprofit is NOT restricted from owning a for-profit business (although there are some important considerations when doing this). There are also several benefits a nonprofit can realize by owning a for-profit business.
One benefit is that by owning a for-profit business, a nonprofit can expand its activities beyond its charitable purpose without jeopardizing its nonprofit status. A nonprofit can earn income from unrelated business activity and pay taxes on this income, but at some point the activity may become so substantial that the nonprofit status of the corporation may be impacted. Unfortunately, there is no bright line for how much activity is too much. Additionally, it is not always clear under the Internal Revenue Code when an activity is not substantially related to the charitable purpose. To avoid these risks, separating the business from the nonprofit can be a smart decision.
Another benefit of separating for-profit activities from the nonprofit is shielding the corporation from potential liability of the for-profit activities. Organizing a limited liability company for the for-profit activities is a good way to shield the nonprofit while simultaneously creating limited liability for those activities.
Other benefits of separate entities include attracting outside investors and attracting and compensating employees. A for-profit business may need revenue from other sources, and it can attract investors that want to see a return on their investment, whereas this is not an option for a nonprofit organization. Additionally, a for-profit business is not regulated by the same state and federal compensation laws that a nonprofit is, making it easier to pay employees.
There are also privacy benefits that for-profit businesses enjoy that nonprofits cannot. For instance, when filing annual returns to the IRS, Schedule B for Form 990 requires disclosures of contributors, which includes the contributor’s name and address. There is nothing comparable to this for a for-profit business.
If you need help with your nonprofit organization or for-profit business, contact the business attorneys at Berkshire & Burmeister to discuss your needs with you!