Don’t Forget the Sub

June 19, 2011

Authored by: Keith Kehrer

Charity leaders often come up with creative ways to increase a charity’s cash flow.  Although these revenue producing activities are often tangentially related to the charity’s exempt activities, often these activities may be considered commercial or for-profit activities that could jeopardize the charity’s exempt status.   One strategy to protect the charity’s tax-exempt status is to conduct such activities through a for-profit subsidiary.  The IRS recently released Priv. Ltr. Rul. 201123036, confirming the long-standing position that a charity’s interest in a for-profit subsidiary will not jeopardize exempt status if properly structured.Among other reasons, the charity in the letter ruling sought to use the subsidiary stock as “acquisition currency,” attract prospective partners by making it possible to offer a non-controlling equity investment, and attract and retain key employees with an equity-based compensation system.   As long as (i) the  subsidiary is established with a bona fide intention that the subsidiary will have a real and substantial independent function, (ii) the charity and subsidiary maintain corporate separateness (charity’s officers do not control and are not involved with the day-to-day activities of the subsidiary, (iii) the charity and the subsidiary maintain corporate formalities (e.g., separate bank accounts, separate records, separate board meetings, etc.), and (iv) deal at arm’s length and fair value, the for-profit subsidiary’s activities should generally not be attributed to the charity and will not jeopardize the charity’s exemption.  Special care must be exercised to avoid private inurement and excess benefit where the charity’s directors, officers or other insiders will also be shareholders.