Joint Ventures Without Jeopardy

Sometimes a nonprofit has an asset, such as a strong brand, valuable intellectual property, or a unique program, that is brimming with untapped potential. A for-profit company might have exactly what the nonprofit lacks: capital, commercial expertise, and market reach.

Joint ventures between nonprofits and for-profits can unlock new revenue, expand audience reach, and increase impact. They can also trigger complex tax and compliance issues that, if ignored, could cost a nonprofit its tax-exempt status or generate ongoing unrelated business taxable income (UBTI).

The Two Big IRS Concerns

If you are a nonprofit considering a joint venture with a for-profit partner, you need to address two core risks.

1. Losing Tax-Exempt Status – Section 501(c)(3) of the Internal Revenue Code requires that an organization operate exclusively for charitable purposes. The Supreme Court in Better Business Bureau v. United States, 326 U.S. 279 (1945), held that a single substantial noncharitable purpose can destroy exemption. If a joint venture shifts too much control to the for-profit partner or primarily serves private interests, the IRS may revoke exemption.
2. Generating Unrelated Business Taxable Income – Under IRC §§ 511–514, income from activities not substantially related to a nonprofit’s exempt purpose is taxable. In partnerships and LLCs taxed as partnerships, Treas. Reg. § 1.512(c)-1 attributes the character of partnership income to the partners, meaning unrelated business activity conducted through a joint venture can result in UBTI.

What Counts as a Joint Venture

A joint venture for IRS purposes can take the form of a separate legal entity, such as a partnership, LLC, or corporation, or it can be purely contractual. The IRS focuses on whether the parties are actively and jointly operating a business, with shared control, shared risks, and shared rewards.

In Revenue Ruling 98-15, the IRS treated a contractual collaboration between a nonprofit hospital and a for-profit health system as a joint venture because the parties shared governance and profit participation.

Passive investments are different. Buying stock, investing in a mutual fund, or licensing your intellectual property in exchange for royalties without operational control generally does not create a joint venture for these purposes. Revenue Ruling 2004-51 confirms that if a nonprofit’s participation is insubstantial and furthers its exempt purpose, the activity may not jeopardize exemption, and royalties are generally excluded from UBTI under IRC § 512(b)(2). To determine whether your arrangement amounts to a joint venture for tax purposes, consider the following questions:

• Do you and a for-profit partner share operational control over a business activity
• Do you jointly make strategic and day-to-day management decisions
• Do you share in both the risks and the profits of the arrangement
• Is the activity more than an insubstantial part of your overall operations
• Is the arrangement governed by a partnership, LLC, corporation, or detailed contract that outlines shared responsibilities

If you answer yes to most of these, you may be in joint venture territory and should structure carefully to comply with the IRS’s control and purpose requirements. If you answer no to most and your role is limited to collecting passive income without operational control, you are likely outside the joint venture rules, though other tax considerations may still apply.

Why Control Matters

Control is the centerpiece of joint venture analysis. The Supreme Court’s decision in Better Business Bureau established that an organization fails the operational test if it has even a single substantial noncharitable purpose, no matter how many charitable purposes it serves. This is why a joint venture that gives significant control to a for-profit partner can be so dangerous — it risks shifting the organization’s operations toward private, commercial goals.

The Tax Court’s decision in Plumstead Theatre Society v. Commissioner, 74 T.C. 1324 (1980), aff’d, 675 F.2d 244 (9th Cir. 1982), shows the flip side. There, a nonprofit theater company entered a limited partnership with private investors to finance a play. The IRS argued that participation in a for-profit partnership was inherently disqualifying. The court disagreed, finding the nonprofit retained full control over the charitable aspects of the production and the private partners could not influence the mission.

These two cases frame today’s IRS approach. Post-Plumstead, the IRS applies a two-part test:

1. The joint venture’s activities must further a charitable purpose.
2. The nonprofit must be able to operate exclusively for that purpose, which typically requires retaining control over the venture.

When nonprofits fail this control test, courts have upheld IRS revocations. In Redlands Surgical Services v. Commissioner, 113 T.C. 47 (1999), aff’d, 242 F.3d 904 (9th Cir. 2001), the nonprofit ceded equal control to the for-profit partner, undermining its ability to ensure charitable priorities. In St. David’s Health Care System v. United States, 349 F.3d 232 (5th Cir. 2003), the court questioned whether a nominal dissolution right constituted real control when exercising it would have crippled the nonprofit financially.

Common Structures

Mission-Driven Operating Joint Venture – The nonprofit retains majority control in the governing body and the venture’s activities directly further its exempt purpose. This approach, modeled on the favorable scenario in Rev. Rul. 98-15, is safest for exemption but may not be attractive to for-profit partners seeking more control.

Joint Venture via a Taxable Subsidiary – The nonprofit forms a wholly owned taxable subsidiary to hold its joint venture interest, as recognized in GCM 39326 and Ltr. Rul. 199938041. The subsidiary pays corporate tax on its share of profits; the nonprofit receives tax-free dividends. This can shield the nonprofit from unrelated business activity but comes with formal separation requirements, such as independent governance, capitalization, and arm’s-length dealings.

Passive Licensing or Royalty Deal – The nonprofit licenses intellectual property to a for-profit in exchange for royalties, which are generally excluded from UBTI under IRC § 512(b)(2) if the nonprofit has no operational role. This avoids joint venture status but sacrifices operational control over the brand.

Practical Tips Before You Sign

• Determine whether your arrangement is operational or passive
• Include mission priority language in governing documents
• Document all terms at arm’s length to avoid private benefit or inurement under § 501(c)(3)
• Preserve rights to use your own brand or intellectual property for charitable purposes
• Model the after-tax results so you understand the net benefit to the nonprofit

The Bottom Line

Joint ventures between nonprofits and for-profits can be powerful tools for mission growth, but they require careful attention to IRS guidance, including Better Business Bureau, Plumstead Theatre, Redlands Surgical, St. David’s, Rev. Rul. 98-15, Rev. Rul. 2004-51, and applicable Treasury regulations. The right structure can generate new resources and partnerships without jeopardizing exemption or creating unnecessary tax liability. The wrong one can put your mission and tax status at risk.

Ellis Carter is a nonprofit lawyer with Caritas Law Group, P.C. licensed to practice in Washington and Arizona. Ellis advises nonprofit and socially responsible businesses on federal tax and fundraising regulations nationwide. Ellis also advises donors concerning major gifts. To schedule a consultation with Ellis, call 602-456-0071 or email us through our contact form.