As more and more tax-exempt organizations seek new and novel approaches to solving social problems, we are encountering more groups that want to draw on the expertise and capital of for-profit companies. This trend has led to a resurgence of interest in joint ventures between nonprofits and for-profits “ a phenomenon that has traditionally been most common in the healthcare sector.
Tax-exempt nonprofits entering into joint ventures with individuals or for-profits must take care to structure the joint venture so that it does not provide improper benefits to the for-profit joint venture partner. If a joint venture relationship is not carefully structured, the tax-exempt organization’s involvement could jeopardize its tax exemption or produce unanticipated unrelated business income.
A tax-exempt corporation that is a prospective partner in a joint venture (whether the joint venture will be organized as a contractual arrangement, LLC, partnership, or corporation) must take care to design the joint venture relationship in a manner that reduces this risk.
To reduce the risk to the tax-exempt organization, the tax-exempt partner should exercise sufficient power and control over the joint venture’s activities to ensure the joint venture operates in furtherance of its tax-exempt purposes. Tax-exempt organizations must be particularly careful when entering into joint ventures structured as partnerships or LLCs because the IRS attributes the activities of such entities to its owners.
To evaluate whether a tax-exempt corporation’s participation in the joint venture is in furtherance of tax-exempt purposes, the IRS will look at certain issues.
IRS Key Points in Terms of Tax-Exempt Purposes for Nonprofits’ Joint Ventures
- Does the tax-exempt partner appoint a majority of the joint venture’s governing body?
- Do the joint venture’s governing documents state that the joint venture will be operated consistently with the tax-exempt partner’s charitable purposes?
- Does the tax-exempt organization have veto power over significant for-profit joint venture actions?
- Does the tax-exempt organization have the ability to require the joint venture to act?
- Will a for-profit entity (whether a partner, a partner’s affiliate, or an unrelated third party) manage the operations of the joint venture? If so, what is the term of the management contract? How are the management fees determined?
- Does the tax-exempt partner have the ability to require the joint venture to put charitable purposes ahead of economic objectives?
- Will the compensation paid to the joint venture’s officers and vendors (especially the for-profit partner or any affiliate) be reasonable in light of the services or goods provided?
- Will the joint venture use space financed by tax-exempt bonds? If so, have the implications of such “bad use” on the tax exemption of the bonds been considered?
Nonprofits considering going into business with for-profit organizations should give serious consideration to how they will ensure the joint venture operates in furtherance of its tax-exempt purposes. For-profits considering going into business with tax-exempt organizations should consider whether they are willing to live within these limits.
Ellis Carter is a nonprofit lawyer with Caritas Law Group, P.C. Ellis advises nonprofit and socially responsible businesses on corporate, tax, and fundraising regulations. Ellis is licensed to practice in Washington and Arizona and advises nonprofits on federal tax and fundraising regulations nationwide. Ellis also advises donors with regard to major gifts. To schedule a consultation with Ellis, call 602-456-0071 or email us through our contact form.