Establishing an Affiliated Organization.

Nonprofit associations come in all shapes and sizes, with governing structures and policies that vary accordingly. For many organizations, however, the restrictions imposed by their particular tax-exempt status may limit the operations of the organization. If the organization wishes to engage in activities that are inconsistent with its tax-exempt status, or if it may be more appropriately and beneficially served by another status, the organization's leadership should consider forming an affiliated organization. In this article, Karen Cipriani explains why and how to establish an affiliated organization.

Given the activities of most tax-exempt associations, two arrangements tend to be the most effective in expanding the organization's permissible activities: establishing a Section 501(c)(3) charitable and educational foundation, or creating a for-profit corporation. Several examples illustrate circumstances in which it may be appropriate to establish such an affiliate.

* A Section 501(c)(6) organization, wanting to separate its professional activities from its educational activities, may establish a Section 501(c)(3) organization to manage its educational, research, grant recipient, and similar activities. The Section 501(c)(3) affiliate is permitted to accept donations that are tax-deductible by the donor, which the Section 501(c)(6) may not. The Section 501(c)(6), on the other hand, may form and maintain a political action committee, which a 501(c)(3) cannot do; or engage in unlimited amounts of lobbying, which a 501(c)(3) can do only in limited amounts.

* Under the Lobbying Disclosure Act, a Section 501(c)(4) organization may not participate in any lobbying activities if the organization receives federal grants, awards, or loans; it must choose to do one or the other. The Section 501(c)(4) may choose to establish a separate Section 501(c)(3) organization to apply for and administer federal funds, while the Section 501(c)(4) conducts lobbying activities for the benefit of the membership.

* A Section 501(c)(6) organization may find that much of its activity generates unrelated business income subject to tax. For example, extensive advertising revenue, actively managed insurance programs, or individual fee-based consulting service agreements could all generate significant UBIT-eligible income. To avoid jeopardizing its tax-exempt status by receiving too much unrelated business income, the organization can establish a for-profit affiliate to take over these activities. Either way, the net revenue is taxable; however, a subsidiary protects the main organization's exemption for other related income.

Following guidelines 

Incorporating an affiliate organization is surprisingly easy. Articles of incorporation must be drafted and filed to meet state law mandates and the requirements of the organization's taxable or tax-exempt status. Bylaws should also be drafted to reflect the purposes of the new organization, its relationship to the parent organization, and other governance policies. New organizations must also obtain an Employer Identification Number by filing Form SS-4 with the Internal Revenue Service. Finally, if the new affiliate organization plans to seek federal tax exemption, the IRS requires that it file a detailed application related to the affiliate's particular status.

Clarifying relationships

Special attention should be paid to the language used in drafting articles of incorporation, bylaws, and other governing documents with respect to whether the new affiliate is to be a nonprofit or for-profit organization.

If the parent organization intends to direct the activities of an affiliated 501(c)(3) nonprofit organization, the affiliate's bylaws should reflect this; the bylaws of Section 501(c)(3) foundations affiliated with another organization often provide that a certain portion of the Section 501(c)(3)'s board of directors will be appointed by the parent organization, and that amendments to the bylaws or other governing documents must be approved by the parent organization. Applications for tax exemption should similarly disclose this relationship. Individuals working for both the parent and the affiliate should be made aware of the special legal rules governing Section 501(c)(3) tax exemption, such as the prohibition on participating in federal election activity, deductibility issues, lobbying limitations, and the like.

Establishing a for-profit affiliate raises a new set of strategic issues, such as short-and long-term goals and options for the corporation, the portion of revenue to be allocated to the parent, the type of governing structure to be put in place, and the amount of capital initially required. There could also be a significant amount of documentation involved if the affiliate intends to issue stock. Clearly, the for-profit entity must become familiar with an entirely different set of tax laws and reporting documents, state and local filing requirements, and other corporate matters.

Considering final details

Other factors unrelated to the incorporation process should be taken into account when setting up any kind of affiliated organization.

* If the affiliate plans to share office space and other costs with the parent organization, both parties must enter into a cost-sharing agreement to allocate expenses and ensure that they are treated properly for tax purposes. Regardless of shared arrangements, employment, payroll, and accounting policies and procedures should be developed.

* If the new organization plans to use the parent's name, logo, mailing lists, or other intellectual property, creating a license agreement between the parent organization and the affiliate may be necessary.

* The new organization's leadership may consider registering its own copyrights and trademarks with the U.S. Patent and Trademark Office.

* At some point, it might become necessary to negotiate contractual arrangements with technical service providers, publishers, and other outsourcing partners and vendors.

In any case, the parent and the affiliate should establish the terms of their own corporate relationship. In the process they should assess the ways in which the organizations can maximize the benefits available to their constituents and work together to achieve those goals.

Karen L. Cipriani is an associate and Jerald A. Jacobs is a partner at the law firm of Shaw Pittman, Washington, D.C. Jacobs edits this column.