Legal/Tax Structures for Combination of a Non-Profit and Related LLC
Non-profit and for-profit organizations can enter into a number of partnership types that retain both entities separately, while requiring different expectations to be met by both parties, and of the union as a whole. Such conjunctions include general and limited partnerships, joint ventures, and multiple types of service-level agreements. Below you will find a breakdown of each type of possible structure that can be formed between a non-profit and for-profit without eradicating the non-profit entirely, as well as the associated legal, administrative, and tax implications.
General partnerships between a non-profit and a for-profit LLC require a written and enforceable agreement that binds one party to the other. The for-profit is usually binded to the non-profit for tax purposes, and the partnership must pass certain requirements by the Internal Revenue Service (IRS) in order to retain the tax-exempt status from the non-profit organization. The requirements to remain tax-exempt according to the IRS are as follows:
1. The partnership's priority must remain the same as that of the non-profit, according to the exempt purposes permitted for 501(c)(3) organizations. Such permitted exemptions include charitable sources.
2. The partnership must put the goals of the non-profit first, above all else. If the partnership comes before the goals of the non-profit, then the conjunction is not tax-exempt.
The IRS will investigate official documents and ask specific questions that will be discussed further in this writing that determine the accuracy for the above requirements. According to the IRS, charitable includes, "relief of the poor, the distressed, or the underprivileged." Assuming that the expectations above are met, then a general partnership between a non-profit and for-profit LLC can move forward with administrative details.
In this sort of agreement, operations of the partnership are governed through a board which is formed by both parties in the agreement. The board must be comprised of at least 51% non-profit personnel, but both parties are equally responsible for any liabilities.
There are multiple types of service-level agreements that non-profits and for-profit LLCs can enter into. Within these partnerships, both entities still operate independently, but they interact with one another through a designated contract. Oftentimes, one party gives up their decision-making power to the other — it is usually the for-profit that is required by the IRS to submit to the non-profit for tax purposes.
MUTUAL SERVICE AGREEMENTS
Mutual service agreements are a specific type of partnership between non-profits and for-profits that revolve around the performing of services together without the transfer of money between the two parties. The services tend to revolve around the non-profit goals, while the for-profit works to back up the project.
License agreements are another type of partnership between non-profits and for-profit LLCs. In this type of agreement, an official document of concurrence is formed that permits the sharing of one company's intellectual properties for another purpose. This might include trademarks, patents, logos or names in order to grow the support for an event or public statement, and may also produce more revenue for both companies.
In a resource-sharing agreement, a non-profit and a for-profit LLC may come together and share physical materials in order to fulfill goals of one or both entities. This is specifically common for 501(c)(3) organizations, but it is important that such agreements do not exceed a fair market price for non-profit institutions. If the cost for using a for-profit company's resources is not a market price, then it can potentially cause major issues with insurances, licenses, employees, and more.
This sort of partnership is especially helpful for non-profit organizations that are seeking to collaborate on a deeper issue related to their organization with a for-profit LLC, but do not require the entire LLC in order to reach their goal. In such situations, it is helpful for both entities to hire a third party together that will sponsor the partnership and be responsible for the operations as a whole. This third party takes much of the weight off of both companies by overseeing the entire project, but still permitting the parties to oversee the minor day-to-day operations.
Joint Ventures/Limited Partnerships
In a joint venture partnership, also known as a limited partnership, a for-profit LLC will work with a non-profit organization to provide support for their goals, while still remaining two different entities. Non-profit companies enter into these agreements in order to gain access to advantages and consumers that they otherwise could not reach, while for-profit LLCs often enter to take advantage of available tax credits and gain a wider market audience for their business.
In a limited partnership, parties are not required to prioritize the goals of another party over their own. However, in order to maintain the tax-exempt status that comes with being a 501(c)(3) charitable organization, it is required by the IRS that at least 51% of the for-profit operations is controlled by the non-profit. For this reason, such partnerships are more widely considered to be joint ventures. These combinations of parties can provide support for both businesses, but can also sometimes negatively affect the non-profit aspects. In order to assure that a joint venture partnership between a non-profit and for-profit LLC is legal and still tax-exempt, the following rules from Revenue Ruling 98-15 must be met:
1. The joint venture partnership must prioritize the non-profit's purpose.
2. The joint venture partnership must explicitly work for the goal of the non-profit, and only benefit the for-profit by incidence.
3. Non-profit personnel must have control of more than half of the partnership.
4. The goals of the non-profit come above all else, even the joint venture partnership.
If the above points are not met, it could jeopardize the tax-exempt status of the 501(c)(3) organization. The IRS will often investigate the above points through the following questions in order to determine the status of a partnership:
1. Does the non-profit make up the majority of the board?
2. Do official documents of the partnership indicate that the joint venture is always workings towards the goals of the non-profit?
3. Does the non-profit organization have the power to veto decisions made by the for-profit?
4. Can the non-profit require the for-profit to complete certain actions through the partnership?
5. Who will manage the partnership? Is there a third party involved? If so, how are fees for the third party determined?
6. Does compensation for the third party for for-profit LLC meet a fair market value for the provided services or goods?
When the above six questions are met, then the IRS will likely conclude that the joint venture partnership is in good standings, and the non-profit will retain their tax-exempt status.
Tax & Legal Implications of Agreements
With all of the above stated partnerships, there are a number of legal and tax ramifications that can take place if not done correctly. Such implications relate to not properly reporting of information, as well as not upholding agreements. Below are the requirements of all agreement types above, according to the law and the IRS.
SEPARATION OF ENTITIES
Proper separation must be maintained between the non-profit and for profit organizations. This includes separate bank accounts and books, as well as indicating corporate status of the LLC on an annual basis during the partnership. If not completed by both parties involved, consequences from the IRS may arise.
PROVISION OF SERVICES
The division of services and costs must be divided fairly and dictated through cost allocation documents or other generally accepted methods. Employee agreement documents must be set in place if necessary, in order to avoid issues when completing the IRS Form 990. "Due to" and "Due from" accounts need to be settled frequently so that balances that may not be repaid do not accumulate. This is necessary if the LLC is not wholly-owned. Partnership terms cannot put the non-profit at a disadvantage; services must be granted at a fair market price.
EXPLOITATION OF NON-PROFIT ASSETS
The non-profit's assets are not to be exploited through the partnership. This is to be avoided through fair-compensation of services, to be documented in writing. The non-profit must have control of their ability to remain tax-exempt through the partnership.
FORM 990 REPORTING
Each party must file their own tax returns with their own activity and balance sheets. All related organizations in the partnership must be filed on Schedule R with their corresponding information. Related organizations controlled by the insiders of the partnership may require reporting on Schedule L. In general, expenditures to any foreign related entities must be reported on Schedule F.
When entering into any of the above partnerships between a non-profit and a for-profit LLC, it is important to ensure that the non-profit is not placed at a disadvantage in any way. The goals of the non-profit must remain the number one priority of the partnership, even above the alliance itself. If IRS guidelines are not met through such affiliations between two entities, the non-profit could potentially lose their tax-exempt status.