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.
By creating a separate corporation, your non-profit generally will not be liable for the debts and obligations of the social enterprise because they are two separate legal entities. However, there are times when the courts will “pierce the corporate veil” between the two entities. This occurs most often when you commingle the two organizations’ assets and generally fail to treat them like two separate organizations.
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The IRS has also been known to consolidate a non-profit organization with its for-profit social enterprise and treat them as one entity in certain circumstances. To avoid this (and the veil piercing problem generally):
If you have questions about your non-profit’s social enterprise, whether it’s an in-house program or a separate legal entity, then: