We are sometimes asked by a client if they should set up a subsidiary for some part of their operations. A subsidiary is usually necessary for 2 situations: First, the nonprofit is undertaking an activity where it seeks to reduce liability. Second, it wants to avoid the tax consequences of an activity, such as when it is undertaking an activity that is unrelated to its mission or engaging in lobbying. The subsidiary can be either taxable or nontaxable, depending on the activity or goals of the nonprofit organization.
Subsidiaries are usually formed as C corporations if the goal is to avoid tax on unrelated business income. There would be no tax on income going from the sub to the parent. However, avoid a subchapter S corporation because income from the Sub S corporation will cause the nonprofit to pay unrelated business income tax. There may be times when a limited liability company may be appropriate, but exercise caution because the income is automatically attributed to the parent.
Limited Liability Company
One situation where a limited liability company (usually a single member LLC) is appropriate is to receive a gift from a donor that may have risk attached, such as a parcel of real estate. The SMLLC is treated as an arm of the charity and the donor can still receive a tax deduction. The charity should indicate on the receipt that the single-member LLC is owned by the charity. If you set up an LLC for any reason, including a single-member LLC, make sure you have an operating agreement for it as well.
The subsidiary can be “owned” by the nonprofit in one of several ways:
- First, the Board of the parent can be the Board of the subsidiary.
- Second, officers of one can be officers of another.
- Third, employees may overlap.
In any event, if you are considering setting up a subsidiary, be careful that the parent does not exercise too much control over the subsidiary. This is especially important in cases where the sub is engaged in an unrelated activity. It is possible the IRS may disregard the sub and state it is in substance one entity.
These are just a few of the considerations in setting up a subsidiary. Much depends on the goals of the organization and the activity that may be involved. If you think you may need a subsidiary call us for help. We can give you advice on how best to set it up.