The Use of Affiliated Organizations
A. Some Advantages of Affiliated Organizations
1. Activities that result in the production of unrelated business income can be spun off into a separate corporation, thus, insulating a tax exempt organization from UBIT problems. Examples include bookstores, pharmacies, etc.
2. Activities that require state licensing, the use of licensed professionals, or which have a high liability potential, can be spun off into a separate corporation to insulate a nonprofit from malpractice and tort liability. Examples include schools, day care centers, counseling centers, etc.
3. Activities that require state certification or are subject to special auditing requirements can be spun off into a separate corporation to insulate a nonprofit from state audits when the affiliate is audited. The same tactic can be used to insulate a nonprofit from IRS audits when an affiliate is audited in some cases.
B. What is an Affiliated Organization?
1. Parent-Subsidiary: When the nonprofit owns or controls the voting power in another corporation (whether profit or nonprofit).
3. Legal Affiliate: When the employees of a nonprofit control another corporation through board membership. Tests of Legal Affiliation:
a. The degree to which the directors or trustees of one corporation are employees of another organization.
b. The degree to which the officers or managers of one corporation are employees of another organization.
c. The degree to which the laborers or work force of one corporation are employees of another organization.
4. Related Parties ("Accounting Affiliate"): When one corporation controls a majority of the revenue stream of another corporation.
C. Risks associated with an unwanted degree of affiliation.
1. Unwanted consolidated financial and tax reporting.
a. May result in imputed income.
b. May result in UBTI to the nonprofit.
c. May result in unwanted additional disclosures.
2. Possible loss of tax exempt status.
a. From too much UBTI.
b. From private inurement (too much benefit to profit corp.)
c. From tax exempt purpose no longer viewed as primary.
3. Liability of one entity for the debts of another (alter ego theory).
a. One corporation is subservient to the other's will.
b. Formalities of separate organizations are not maintained.
c. Too much sharing of facilities, personnel, equipment, etc.
D. Financial Transactions should be kept "arms-length."
1. Independent review and approval of transactions by both organizations' boards and management.
2. Tax exempt org. cannot sell services, products or labor at less than fair market value to a profit corporation.
3. Loans by nonprofit must be at FMV.
4. Potential need for independent review by legal counsel.
5. Watch out if funds are transferred solely by internal account transfers rather than through bank drafts, etc.
E. Risks associated with loaned employees.
1. Who is a loaned employee?
a. A "loaned employee" is any wage earning employee of this organization who, in the course of his employment, performs services of any kind for any other organization.
b. Services are performed for an organization other than this organization if the services are on-going and primarily: 1) for the benefit of; or 2) directed or controlled by; the other organization.
2. Risks:
a. An employer is legally liable for the actions of its employee in the course of his employment. When an employee's activities are controlled by another organization, the employer loses the ability to control its liability exposure.
b. Because this organization is a tax exempt corporation, the activities of its employees must be directed primarily toward an exempt purpose, and only unsubstantially toward other purposes, or its tax exempt status could be revoked.
c. When an employee is loaned, care must be taken to ensure that financial transactions are properly accounted for.
3. Remedial steps include documenting and monitoring:
a. Nature of receiving organization.
b. Nature of loaned employee's activities.
c. Loan should be temporary.
d. Obtain proper indemnities.
4. Generally:
a. A nonprofit organization should loan its employees on the same basis as it spends its money.
b. An employee loan does not serve a business purpose unless the organization is paid for the use of its employee.
c. Conversely, an employee loan serves an exempt purpose only if the receiving organization is also tax exempt.
d. If an employee loan fails to serve either an exempt purpose or business purpose of the employer, it is a diversion of assets to a non-exempt purpose.
F. When nonprofit insiders are also insiders for a related organization.
1. The duty of every insider is to act in the best interests of the organization he or she serves. If a director cannot lay aside the wishes of his or her employer and act in the best interests of the affiliate, he or she should resign.
G. Exposure to "piercing the corporate veil."
1. Any nonprofit corporation which fails to adequately maintain its corporate records, fails to file a Michigan Annual Report, or lacks an arms-length relationship with an affiliate may be deemed a `sham' corporation or the `alter ego' of another person.
2. A nonprofit in this position is postured for `piercing the corporate veil,' a term which means that creditors and litigants may disregard the corporate entity and seek damages from the individual employees and control persons of the nonprofit.
3. Protective measures to employ to guard against this potential: 1) maintain a high level of record-keeping; 2) comply with all state filing requirements; 3) monitor all affiliate relationships.
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