One of my favorite parts of my job as a lawyer is helping nonprofits with their work in the community. Most of these groups are formed as 501(c)(3), named for the section of the tax code that grants tax-exempt status. In addition to the organization itself being tax exempt, donations to these groups are tax deductible for the donor. I always get a lot of questions from these groups about the legal restrictions they face in exchange for this tax-exempt status. One of the most common questions is about the type of activities they can do to raise money.
501(c)(3)s are not actually restricted in any way in the ways they can raise money. Charities and other groups may engage in activities that generate “profits,” which means generating income for the group. Examples of this could be selling ads in a newsletter, holding a bake sale, or renting a building owned by the group. But regardless of where a nonprofit organization’s income comes from, it must be used for the purposes stated in the group’s formation documents, whether religious, educational, or charitable. Also, normally none of the profits can go to any individual, except as a reasonable salary duly approved by the leaders of the non-profit organization.
The fact that a nonprofit group can engage in commercial activities on its own does not necessarily mean that it must do so directly. If business activity can be easily separated from non-profit activities, such as leasing a building or running a bookstore or grocery store, the business may need to be run by a separate organization. The other organization could be a for-profit corporation in which the nonprofit organization owns shares, a foundation, trust, or other charitable organization. This separate organization, which owns the business asset, is called a subsidiary.
Structuring business activities in this way could ensure that the nonprofit organization can use business income for religious, educational, or charitable purposes and also protect the organization from any liability generated by business interest. For example, if a nonprofit organization rents part of a business that it directly owns and someone sues them, either for breaking a lease or for any accident in the building, the rest of the nonprofit’s assets profit will be at risk. Proper formation of a subsidiary to hold real estate or other business assets will generally limit potential liability to only assets held by the subsidiary and protect the nonprofit’s other property.
However, to obtain this protection, the nonprofit organization must ensure that it complies with all corporate formalities. These formalities must be respected as regards the non-profit entity and the subsidiary. Both groups must have presented all the corresponding documents before the state and federal authorities. They should also have a separate administration, hopefully with some unusual administrators. The managers must meet regularly and properly authorize the activities of the group, including monetary transfers from the subsidiary to the non-profit parent. Making sure all of these rules are followed is also important for managers and leaders of a nonprofit organization, because it can protect them from personal liability.
This is just a brief overview of some of the steps churches, charities, and other nonprofits can take to protect their assets and ensure they can carry out their mission. This article is not intended as legal advice and does not create any type of attorney-client relationship. Any nonprofit organization, other group, or individual is encouraged to contact a licensed attorney for further information or advice regarding the contents of this article.