Recap: In Part 1 of this Series, we discussed the various options for structuring a social enterprise, and in Part 2, we discussed the unique problem non-profit organizations can face when they generate Unrelated Business Taxable Income (UBTI). But how your non-profit operates its social enterprise can also have a major impact on the organization's tax-exempt status.
In addition to the potential UBTI issues, non-profits often create separate corporations for their social enterprise endeavors so that the liabilities of one do not threaten the assets of the other. Like any business venture, the question has to be asked—what happens if the social enterprise fails? Will the nonprofit be accused of using funds inappropriately, particularly funds that could have better supported its charitable purpose? Could the failure of the social enterprise impact the non-profit’s financial viability, especially if the non-profit was using its own funds to start the social enterprise? Separately, does the social enterprise itself pose any risks that could be subject to litigation? Non-profit boards must carefully consider the potential risks a social enterprise activity might create. Creating a separate corporation to “house” that risk and operate the social enterprise can protect the non-profit parent organization (and its separate assets).
But (and there’s always a but), creating a separate corporation for your social enterprise activity is not a get-out-of-jail-free-card. Keep reading to learn about best practices to follow when operating both a non-profit and a social enterprise corporation.
In Part 1 of this Series, we discussed the various options for structuring a social enterprise. This week we turn to one of the unique issues impacting non-profit organizations who try to raise money by starting a social enterprise--unrelated business income. As a non-profit (and for this blog post, we're going to focus on 501(c)(3) organizations), how do you start a social enterprise without jeopardizing your charitable status and without incurring unexpected tax liabilities?
Nonprofits must be organized and operated exclusively for religious, educational, scientific or other charitable purposes. The general rule for business revenue earned by a nonprofit is that the revenue must be related to the organization’s charitable purpose. Otherwise, the revenue is treated as unrelated business taxable income (“UBTI”). The IRS requires nonprofits to pay tax on UBTI when engaged in commercial business activities in order to prevent tax-exempt organizations from having an unfair advantage over for-profit, taxable competitors.
The idea of "doing good while doing well" certainly isn't new, but it is increasingly popular in both the business and non-profit worlds. Increasingly, non-profits are developing social enterprises to help the organization become financially sustainable without being as dependent upon the good will of donors. On the other hand, some for-profit businesses are intentionally being established with the mindset that the business's social impact or mission is at least equally as important as earning a profit.
A social enterprise is a business that is both purpose-driven and market-driven. Unlike a typical for-profit business, a social enterprise is not exclusively dedicated to maximizing profits, but unlike a typical non-profit organization, a social enterprise does sell goods or services to raise revenue while addressing a larger societal issue. Social enterprises can range from socially responsible or philanthropic-minded for-profit businesses to revenue-generating arms of traditional non-profit organizations.
How is forming a social enterprise different from establishing other types of business entities? And how should you structure a social enterprise?