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Understanding related entities: an overview of how related foundations and taxable subsidiaries work.

Any volunteer leader new to the association world may easily become confused by the relationship of an association to its foundation and any subsidiaries. Briefly, here's how some of the most common types of related entities work.

A reason for being

To justify their separate existence, associations' related entities must have a reason for being that is separate and apart from the main association's exempt purposes.

* Related 501(c)(3) foundations, for example, must have a charitable, educational, or similar purpose that primarily benefits the general public - not the members of an industry or profession, however much that industry or profession might advance the public interest.

* Taxable subsidiaries must have a specific "business" purpose separate and apart from the exempt purpose of advancing an industry in general. Avoiding taxes is not a business purpose. Actually, after certain changes made by the Taxpayer Relief Act of 1997 take effect, hardly any tax advantages will be left for taxable subsidiaries. One significant tax advantage will remain - protecting the main organization's tax-exempt status in the extreme case where unrelated business activity begins to outweigh exempt activity.

The Internal Revenue Service and even an occasional tort law judgment have been known to "pierce the corporate veil" and attribute the related entity's actions back to the main entity. In these cases, the conclusion has been that there wasn't a true separation between the entities, and all activities were really being conducted by the main organization.

Proving separation

How does an association prove the required separation? In general, it's a two-step process. First, it must show that the spin-off organization is separately governed and directed toward its own distinct purposes.

According to case law, the officers and members of the board of directors of a related entity do not have to be an entirely different cast of characters from the main association's leadership as long as the two boards hold separate meetings, which direct each organization toward its own distinct goals and purposes (as evidenced by the meeting minutes).

The second step for an association is to establish true financial separation, meaning that the related entity and parent transact business as if at "arm's length" from each other. This is achieved by maintaining separate bank accounts and books of record and by conducting transactions on a true business basis rather than an "all-in-the-family" basis. Employees may be "shared," but their compensation expense needs to be allocated in a way that truly reflects the division of their time and effort. The IRS considers it a "no-no" for two organizations with supposedly different purposes to have the same person in overall charge of daily operations.

The cardinal rule with related entities: If an association is not prepared to keep up with the details of conducting separate meetings and maintaining separate records and formal documents, it is best not to establish related entities. If their operations can't hold up under scrutiny, related entities will only result in extra time, expense, and confusion.

David M. Duren is a partner at Tate & Tryon, Washington, D.C.
COPYRIGHT 1998 American Society of Association Executives
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Title Annotation:Board Primer
Author:Duren, David M.
Publication:Association Management
Date:Jan 1, 1998
Previous Article:The difference between nonprofit and tax-exempt status: understanding association terminology.
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