Updated June 25, 2020:

Can a nonprofit own a for-profit business? Nonprofit businesses can sometimes drive more income by joining with a for-profit company, depending on the circumstances of the arrangement. Law and tax limits govern the business relationship between the companies. Nonprofit organizations can find it hard to make enough money to keep afloat. Adding to this the global financial crisis, creating revenue can be a challenge. Purchasing a for-profit business can be a solution

Reasons for Creating Nonprofit and For-Profit Businesses

The purposes of creating nonprofit and for-profit businesses vary. A for-profit business strives to have income greater than expenses whose services or products are a means to this purpose. A nonprofit organization provides a service for the community or public as a whole. Nonprofits get their money through donations, member fees or for services to clients.

Nonprofits work with for-profits in one of two manners. In one instance the nonprofit controls 51 percent of the for-profits operations with a major overlap of officers. Secondly, a nonprofit and for-profit are separate entities but interact with each other through some contracts which benefit both.

It's legal for a nonprofit to create a for-profit as at times it can be a necessity. The non-profit can now be involved in money matters as the for-profit is its own business. Even if the activities are not related to the non-profit, it won't jeopardize your tax status.

Example of a Nonprofit Owning a For-Profit

An art museum sells reproductions of paintings or a hospital sells disease-tracking technology, the projects go hand in hand with the mission. But too much profit can have the IRS knocking at your door. Creating a for-profit business avoids this problem. The nonprofit is also protected from legal liability and have investors take the business seriously as it's not just a charity.

Most nonprofits set up as a C corporation to optimize their taxes. A nonprofit can become an owner of an LLC or go into a partnership. The parent nonprofit's dividends are for the most part tax-free. The nonprofit has to be careful though in the way of handling this, as the IRS has held that if both the nonprofit and for-profit have the same directors then they are not separate.

Business Structure of the For-Profit Subsidiary of a Nonprofit

The taxable subsidiary has to be a C-corporation or LLC that opts for C-corporation taxation. Partnerships, LLCs taxed as partnerships or S-corporations don't block money from being treated as unrelated income to the nonprofit.

Dividends are not part of the rule in which income from rents or interest is to be taxed as unrelated income. The distributions from the for-profit to the nonprofit should be in dividends.

Avoid Treating Subsidiaries as Instruments

  • The nonprofit and for-profit should have separate bookkeeping, meetings, tax returns and sign documents in their own corporate name.
  • The nonprofit has to control its subsidiaries through the power it has to vote for and remove directors. It also has the power to approve amendments.
  • The non-profit shouldn't manage the daily operations of its subsidiary.
  • The directors of the nonprofit and the subsidiary can overlap but it's best to have outside directors too.
  • Net earnings can be given to the nonprofit from the for-profit in the form of after-tax dividends. Any transactions between the two entities should be written and approved by the board of directors.
  • When you want to create a for-profit subsidiary as part of the nonprofit, the nonprofit is the majority shareholder and should be able to vote for the board of directors and remove them without reason, as well as approve amendments. The non-profit should contribute to the for-profit's capital.

What If a Nonprofit Wants to Operate as General Partner?

If a nonprofit has an interest in being a general partner in your business, the IRS has to do two tests before this happens. If it doesn't pass then the nonprofit loses its tax-exempt status. The first test is if the partnership has an exempt purpose like religious or education. The second test is whether the nonprofit is able to put its own organization first. If it's not able to put its own nonprofit interests ahead of the partnership then this type of business is unacceptable.

If you need help with a nonprofit owning a for-profit business, you can post your legal need on UpCounsel's marketplace. UpCounsel accepts only the top 5 percent of lawyers to its site. Lawyers on UpCounsel come from law schools such as Harvard Law and Yale Law and average 14 years of legal experience, including work with or on behalf of companies like Google, Menlo Ventures, and Airbnb.