​Forming a business entity like an LLC or a corporation typically provides limited liability protection to the owners. But in certain situations, you can find yourself personally on the hook for the debts and obligations of the business. This week we’re discussing the legal concept of “piercing the corporate veil” and why it’s used so often against small business owners.

In Structuring a Social Enterprise: Non-Profits and Unrelated Business Income, 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.

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.