Subsidiaries of Tax-Exempt Organizations

PART 1
        As tax-exempt organizations have grown in size and complexity, it is not uncommon to find such organizations owning and/or controlling one or more subsidiary corporations. These subsidiary corporations may be nonprofit tax-exempt subsidiaries, or they may be for-profit subsidiaries. In either case, a tax-exempt organization may own and/or control a subsidiary corporation, whether nonprofit or for-profit, without jeopardizing its tax-exempt status.

The For-Profit Subsidiary
        There are many reasons why a tax-exempt organization may establish a subsidiary corporation. In the case of a nonprofit organization having a for-profit subsidiary, the usual reasons for its organization are: (1) that the tax-exempt organization desires to engage in business activities unrelated to its exempt purpose; (2) that the existing or projected revenues from the unrelated business activity are substantial; (3) that the tax-exempt organization prefers not to engage in any unrelated business, income-producing activities because the income may be reportable on IRS Form 990T; or (4) that the unrelated business income-producing activities are so substantial that the income may exceed revenues received by the tax-exempt organization, thus risking the organization's exempt status; (5) that the business activities may carry risks of liability unacceptable to the organization; (6) that the organization desires to own an asset of increasing value; (7) that the organization desires to reward certain employees with increasing compensation, etc.

The Nonprofit Subsidiary
        When it comes to establishing a nonprofit subsidiary of a tax-exempt organization, the usual reasons for its organization are: (1) that certain activities are distinct from and perhaps incompatible with the exempt purposes of the parent organization and are better pursued in an independent, but controlled subsidiary; (2) that the prospect of obtaining government grants is enhanced if certain activities are separated into an independent subsidiary corporation; (3) that substantial revenues will be generated by business activities related to the subsidiary's purposes which may be unrelated to the parent organization's exempt purposes.

The Parent/Subsidiary Relationship
        It is common to use the term "parent/subsidiary" when describing the relationship between a nonprofit organization and its subsidiary. This is true whether the subsidiary is a for-profit or a nonprofit subsidiary. But, a caveat is in order here. The term "parent/subsidiary" is not equivalent to the term "parent/child". This is an important point. While the parent nonprofit organization may incorporate its subsidiary corporation, name its board of directors and officers, enunciate the subsidiary's business purpose or tax-exempt mission, adopt bylaw provisions preserving the parent's control of its subsidiary, etc., it is important that the subsidiary be established and recognized by the parent, as well as third parties, as an independent corporation managed by a board of directors.

Subsidiary Independence: A Stumbling Block?
        The matter of subsidiary independence is oftentimes a stumbling block to the parent nonprofit organization which may view an independent subsidiary as an uncontrolled subsidiary. But recognizing a subsidiary as an "independent" corporation is not the equivalent of regarding the subsidiary as "uncontrolled". At all times. provided that appropriate bylaw provisions are adopted and maintained, the parent has the legal authority to hold the subsidiary accountable to meet "bottom line" financial objectives, to pursue acceptable policy mandates, to fulfill its charitable mission (if a nonprofit subsidiary) and to otherwise conduct its affairs in a manner pleasing to the parent.

PART 2 - Subsidiary Control and Liability Issues