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In order to avoid conflicts of interest, your nonprofit subsidiary should have a mission that does not interact or intersect with the industry of your for-profit business. — Getty Images/SDI Productions

Nonprofits are tax-exempt organizations, which is why many business owners are interested in starting or adding a nonprofit arm to their for-profit operations. However, the IRS has rules to prevent this very loophole. A for-profit cannot own a nonprofit, but there are ways to structure your organization to make it possible to affiliate your corporation with a nonprofit. Here’s how this could work.

Background: nonprofit vs. for-profit

First, it’s essential to understand how these two business entities work. A nonprofit is organized to further a social cause or support a shared mission. These companies are tax-exempt by the IRS since they exist to benefit the public. They’re required to keep financial information public to ensure donations are only for the nonprofit’s further advancement.

“Nonprofits are designed to serve the public, and as such, don't have actual owners. This includes nonprofit corporations, which must meet certain criteria to remain exempt from taxes,” wrote UpCounsel.

Conversely, a for-profit operates with the goal of making money. They sell a product or service to customers, earn an income from the profit, and may also pay shareholders and investors from the profits. These entities are subject to specific IRS tax rules depending on income, location, and business structure.

[Read more: Nonprofit vs. Not-for-Profit vs. For-Profit: What's the Difference?]

Can a for-profit own a nonprofit?

Because the nonprofit doesn’t have owners, a for-profit cannot “own” a nonprofit. However, a corporation can still align itself with a nonprofit without ownership. Adding a nonprofit or charitable arm to your for-profit company is possible, as long as you are careful to follow IRS rules and restrictions.

“Legal conflicts of interest may arise if a 501(c)(3) tax exempt charity is associated with a for-profit parent because the charity must exist to benefit the greater public good, must be headed by an independent board of directors, and generally draw the bulk of their support from public source,” wrote Candid Learning, an education resource for nonprofits.

The low-profit LLC, or L3C as it is known, is structured like an LLC but must have a nonprofit purpose, although it may also generate income.

Belle Wong, J.D., LegalZoom

For-profit business owners seeking to start a nonprofit should be careful to create subsidiaries that are not related in any respect to their for-profit business. For instance, a nonprofit formed by a law firm could sponsor a local animal shelter but should avoid providing legal services in any way. Likewise, the nonprofit should not be entirely reliant on the services or products of a for-profit company to achieve its core mission.

Can a nonprofit form a for-profit arm?

Far more common is a structure in which a nonprofit forms a for-profit subsidiary. A nonprofit can add a for-profit entity regardless of whether or not it is a corporation or limited liability company.

A nonprofit may choose to establish a for-profit subsidiary for a few reasons. Primarily, the leaders in the nonprofit may decide they wish to engage in business activities that don’t pertain to the mission of the nonprofit. Setting up a separate for-profit helps the leaders avoid paying Unrelated Business Income Tax Income (UBIT). And a for-profit structure can also protect the nonprofit from the liability of carrying out certain business activities under tax-exempt status.

Ultimately, forming a for-profit subsidiary of a nonprofit helps a business owner clearly delineate which activities are carried out on behalf of which organization, clarifying for the IRS that the rules and regulations for each entity have been satisfied.

Hybrid nonprofit for-profit entities

Recent years have seen the rise of so-called hybrid organizations, such as benefit corporations or low-profit limited liability companies.

“The low-profit LLC, or L3C as it is known, is structured like an LLC but must have a nonprofit purpose, although it may also generate income,” wrote LegalZoom. “Additionally, an L3C which qualifies as a program-related investment may also be useful in attracting investments from private foundations.”

If you’re interested in a hybrid organization, consult a legal expert who can help you structure this entity in a way that is compliant with IRS regulations.

[Read more: Choosing the Right Nonprofit Type: Which Is Right For Your Business?]

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