Have You Considered a Taxable Subsidiary?
Increasing your income while decreasing your liability
s chambers increasingly offer new
non-dues programs, they may also
be unwittingly increasing their tax
and legal liability exposure. Certainly,
not all non-dues revenue programs generate taxable income. Nor do all of them
heighten a chamber’s legal risk. But,
unfortunately, many do.
A
A better way
In these instances, a chamber could make
use of a taxable subsidiary to carry on
unrelated business activities. By doing so,
chambers can preserve their tax exemption, generate revenue, limit legal liability
and benefit from other legal, political or
practical considerations.
Consider a chamber that offers significant
group health insurance, or retirementrelated, benefits to its membership. To
lessen its tax and liability risks, the chamber could structure their benefits program
as a royalty arrangement. The reality is
that the royalty arrangement is not always
feasible.
Because of the benefits, more and more
chambers are establishing taxable subsidiaries. In general, the formation of a taxable
subsidiary lessens the total level of unrelated business income that the chamber
receives. Therefore, it lessens the concern
that the chamber may be at risk of losing
its tax-exempt status by virtue of receiving
too much of that income. In addition, a
truly separate subsidiary corporation will
have the effect of significantly lessening
the chamber’s risk of liability based on
harm that might be caused by an applicable non-dues revenue program.
The royal treatment
Royalty programs require that the taxexempt organization take a “hands-off”
approach if they want to receive favorable
tax treatment. That means a chamber
would not be allowed to offer significant
marketing, and other services, for the benefit of their program. This “hands-off”
approach does have the added benefit of
lessening the chamber’s general legal liability if someone is harmed as a result of participating in the program. However, most
chambers need to get involved in the marketing, and other activities, to ensure that
the program is a success. Consequently,
many chambers opt to not let the tax and
liability concerns get in the way of what
could be an immensely successful program.
Taking stock
The process of establishing a taxable
subsidiary is relatively straightforward;
it’s similar to the formation of a nonprofit
corporation. Articles of incorporation are
filed with the applicable state, bylaws are
approved, a federal tax identification number is obtained from the IRS, and so forth.
Unlike the chamber, or “parent” organization, the taxable subsidiary will be a
corporation that issues shares of stock.
Usually, the chamber will capitalize the
subsidiary through a transfer of cash and
assets in exchange for all subsidiary stock
that is issued. Dividends paid by a whollyowned subsidiary to a tax-exempt parent
organization are generally not taxable.
However, many other types of payments,
including rents and royalties, will be taxable if the parent owns, or controls, more
than fifty percent of the subsidiary’s stock.
The stock is measured by either value or
voting rights.
Weighing the benefits
True “separateness” (e.g., bank accounts,
boards, stationery) is necessary to avoid
having the IRS, or a court, determine that
the chamber and the subsidiary are in
truth one in the same. This would mean
that their corporate “separateness” would
be disregarded for liability or tax purposes.
Many tax-exempt organizations will
provide space and “lease” the services
of their staff to a subsidiary. Such an
approach is generally acceptable as long
as the subsidiary reimburses the parent
at the parent’s cost for staff time, rent,
facilities use and overhead.
A taxable subsidiary requires detailed
recordkeeping, cost allocation, and other
administrative functions. It can be burdensome to hold separate board meetings,
maintain separate financial records and
time sheets, allocate joint program
expenses and overhead, and utilize separate letterhead stationery, among other
requirements.
If a chamber is unwilling to do what is
necessary to maintain the requisite financial, management and operational separation, then it should not establish a taxable
subsidiary. At the same time, there are significant benefits and opportunities to be
derived from the creative use of taxable
subsidiaries. A forward-thinking chamber
should check them out.
George Constantine is an attorney in the
Associations Practices Group of the law firm
of Venable, Baetjer, Howard and Civiletti,
LLP, Washington, DC. He can be reached
at [email protected].
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Chamber Executive | March/April 2004