The nature of business is that sometimes a nonprofit organization wants to joint venture with a for-profit company to expand the organization’s reach or make use of funds provided by the for-profit company. Such a transaction is possible while maintaining tax-exempt status, but the terms of the arrangement must meet two criteria defined by the IRS.
- The joint venture furthers an exempt purpose.
The activities of the partnership must be primarily related to the exempt charitable purposes of the organization.
- The arrangement permits the charitable organization to act exclusively in furtherance of its exempt purpose and only incidentally for the benefit of the for-profit partners or members.
It’s permissible for a charity to engage in an insubstantial amount of nonexempt activity. But even if a charity furthers an exempt purpose, the exemption is defeated if it also furthers a nonexempt purpose, if the nonexempt purpose is substantial in nature. And, the charity must serve a public, rather than private, interest.
Structure of a Joint Venture
A joint venture between a charitable organization and a for-profit company is typically structured using a partnership or limited liability company (LLC). Each party contributes something of value to the partnership or LLC and thereafter owns an interest in the new entity. Although the new entity can operate, enter into contracts, etc., in its own right, for tax purposes the partnership or LLC is disregarded. The activities of the new entity are deemed to be the nonprofit organization’s activities.
The governing documents must give the charitable organization sufficient control over the management and operation of the partnership so that the charity may insure that the arrangement serves exclusively to further its exempt purpose and only incidentally to benefit the private interests. Then, participation in the venture will not adversely affect its exempt status. Conversely, if the for-profit interests or managers control the decision making, then there is the likelihood, or at least the possibility, that the arrangement confers a greater than insubstantial benefit on the private interests with the result that the charity’s participation in the venture is not considered to further exclusively an exempt charitable purpose.
Examples of JV Structures for Nonprofit and For-profit
Below are three different ways to structure a joint venture between nonprofit and for-profit entities. Other options are also possible.
- The nonprofit and for-profit company contribute equal amounts to the partnership and acquire partnership interests in proportion to their contributions. Distributions are made based on the partnership interests.
- The new partnership is governed by a board of five directors, three of whom are appointed by the nonprofit organization and two of whom are appointed by the for-profit company.
- The new entity agreement expressly provides that the entity will operate exclusively in furtherance of the nonprofit organization’s exempt purpose and forbids the partnership from taking any action that would cause them to lose its tax-exempt status under 501(c)(3) rules. The agreement also states that the nonprofit’s exempt purpose be given priority in the event of a conflict between such interest and the for-profit company’s interest.
Failure to comply with the IRS requirements will result in loss of an organization’s tax exemption. When structuring the joint venture, it’s a good idea to request a private ruling from the IRS confirming the tax treatment of the proposed transaction before finalizing the agreement.
Nonprofit rules are complicated. Please talk with a Salmon Sims Thomas tax advisor if you have questions.