Branching Out: Of Group Tax Exemptions and Other Section 501(c)(3) Organizational Structures for Related Organizations

Many nonprofit leaders start additional organizations for visionary or other reasons, such as to pursue a new tax-exempt mission, to develop regional chapters or groups, to appeal to a broader donor base, or to better address risk management issues.  Various organizational constellations may result, such as group tax exemption, integrated auxiliaries of a religious parent organization, or other related organizations that function within a range of accountability and responsiveness.  Each option carries certain tax and governance implications, as follows.

Group Tax Exemption

Consider Vision Outreach, a hypothetical organization that seeks to eventually grow to have a nationwide reach.  It will likely start as a nonprofit corporation under state law and eventually become a parent (or head) organization.   From the outset, Vision Outreach’s bylaws and other plans anticipate having many affiliated organizations.

Vision Outreach first must apply for and receive its own Section 501(c)(3) tax-exempt recognition.  The organization must then apply to the IRS for group tax exemption recognition, with one or more tax subordinates operating under its general control and supervision.  All tax subordinates must be tax-exempt under a single Section 501(c) category (e.g., all Section 501(c)(3) charities).  Vision Outreach may apply for group tax exemption at the same time as its own tax-exemption application, but it is more typical for a parent to apply later for the group exemption with a roster of proposed tax subordinates. (Note that the initial IRS filing is $850, and the group tax exemption IRS filing fee is an additional $3000.)

Vision Outreach’s subordinates may be included in the organization’s initial request for a group exemption letter, or they may subsequently be added as subordinates in the organization’s annual reporting to the IRS. Significantly, the tax subordinates need not file their own IRS application for tax-exempt recognition.  Rather, Vision Outreach’s inclusion of the subordinate in its group tax exemption documentation is legally sufficient.

To operate under a group tax exemption, a tax subordinate must do the following: (a) initially apply to Vision Outreach for inclusion; (b) expressly confirm its agreement for inclusion; and (c) provide annual and other periodic reports to Vision Outreach, reflecting how its activities and finances promote both organizations’ tax-exempt purposes.  Despite such group inclusion, the tax subordinate must annually file its own version of the IRS Form 990 series (unless the parent includes tax subordinates in a group tax return).

Correspondingly, by including the subordinate on its periodically updated group ruling, the parent represents to the IRS that its subordinates all meet the organizational and operational tests for 501(c)(3) under the Internal Revenue Code.  Thus, the group exemption places a burden on the parent to initially vet each subordinate and to thereafter exercise a reasonable level of administrative oversight so that the parent can annually report to the IRS whether any changes to the subordinate’s structure or operations have occurred.  The tax subordinates may operate under Vision Outreach’s close supervision, such as chapter affiliates sharing a strong identity with the parent, or only under its general oversight and control as needed to satisfy the group tax exemption requirement. 

Operating under a group tax exemption can provide significant advantages.  The tax subordinate does not need to incur the cost involved with obtaining its own tax-exempt recognition. In addition, the tax subordinate may value being part of the parent organization’s “family,” so to speak.  The tax subordinate will enjoy risk management protection as a legally separate entity.  In addition, the subordinate may establish its own bank account, have independent governance, develop its own programming, and raise its own financial support – all to the extent not otherwise constrained by the parent’s own standards for group inclusion. 

Integrated Auxiliary

A serious alternative – at least for religious institutions – is to develop a new entity as an integrated auxiliary.  In its simplest terms, an integrated auxiliary is an extension of a church or other religious organization, separately incorporated but closely aligned as evidenced by a similar name, purpose, shared doctrine, and close institutional relationship.  Perhaps most notably, an integrated auxiliary must be “internally supported” by its parent.  Thus, if Vision Outreach were a church, it could form additional tax subordinates as integrated auxiliaries (e.g., “Vision Outreach Sports Ministry,” “Vision Outreach to Families”), so long as they are closely aligned and obtain most of their funding through Vision Outreach.

No IRS tax-exemption application is required for an integrated auxiliary structure, which is quite a benefit.  As with a group tax exemption, each integrated auxiliary derives its Section 501(c)(3) status from its parent organization.  One drawback, however, is that it can be challenging to explain such integrated auxiliary status to government officials, prospective donors, and others who expect to see an IRS determination letter bearing the integrated auxiliary’s corporate name.

Additionally, it can be challenging for the integrated auxiliary to fulfill the internal support test regarding its finances.  This is particularly true if the new organization seeks to expand fundraising beyond the religious institution’s membership and its other supporters.  Consequently, for example, if Vision Outreach (as a church) seeks to start Vision Outreach Sports Ministry as a social service ministry supported by a broader range of donors, they could not rely on integrated auxiliary status as a viable option under Section 501(c)(3).  Instead, one of the following two options may better apply.[1]

Related Organization

The new entity could simply be a related nonprofit organization, either structurally through bylaws, or organically through shared relationships.  From a structural perspective, Vision Outreach Sports Ministry could operate under Vision Outreach’s oversight and control as a related organization.  For example, Vision Outreach could exercise control through selection and removal of Vision Outreach Sports Ministry’s directors, “ex officio” appointment of key leaders, approval of budgets, periodic reporting requirements, and other control mechanisms.  Alternatively, the related organizations could function together more informally, such as through mutual understandings about board composition and shared faith objectives.  This latter approach certainly provides more flexibility, but it comes with a greater potential for the new organization to stray from its parent.

Under the related organization option, Vision Outreach Sports Ministry would need to independently apply for and obtain IRS tax-exemption approval as a Section 501(c)(3) organization. This step adds a layer of cost and time, but it also will result in definitive clarity about such tax-exempt status – both Vision Outreach and Vision Outreach Sports Ministry would have their own IRS determination letter.

Internal Program Activity

This option may be best suited for an organization whose leaders wish to develop a new program, but not a separately formed nonprofit organization.  Thus, Vision Outreach could establish a sports ministry program, although the program may be run by a separate committee (accountable to Vision Outreach’s governing board) and with a separate bank account (using Vision Outreach’s EIN).  In addition, the sports ministry program’s mission should fall within Vision Outreach’s stated tax-exempt purpose.  If it doesn’t, then Vision Outreach should update its corporate purpose statement in its charter documents.

This option is attractive for incubating, or developing, a new tax-exempt activity.  The program may germinate and grow under the Vision Outreach board’s supervision, develop a loyal base of volunteers and other supporters, and then branch-off as a separate corporation.  Once launched, the new entity will enjoy an established reputation, goals in process, and a solid foundation for establishing public charity qualification.

Conclusion

Each of these organizational options should be evaluated carefully for the best fit under all the circumstances, and with both short-term and long-term considerations in mind. They each offer tax-exempt status, but through different legal structures.  They each feature distinct legal and practical advantages and disadvantages, depending on the goals and needs at hand.  When planning for organizational growth, nonprofit leaders should carefully consider which structure would best support their organization.