It's not only legal for a nonprofit to set up a for-profit subsidiary, sometimes it's necessary. Your nonprofit can legally engage in money-making activities, but if the activities aren't related to your core purpose, that can jeopardize your tax status. Spinning the money-maker off into its own company protects you.
If an art museum sells reproductions of famous paintings or a hospital markets disease-tracking software, those projects tie in to the core mission. Even so, too much profit-making activity could trigger an IRS crackdown on your nonprofit status. The IRS doesn't spell out how much is too much, but creating a separate for-profit business avoids the problem. Founding a new business also protects the nonprofit from legal liability for the money-making ventures. It may encourage investors to take the business more seriously as it isn't a charity.
Setting Things Up
To gain the best deal on taxes, most nonprofits set up the subsidiary as a C corporation, in which the nonprofit owns some or all of the stock. A nonprofit can also enter a partnership or become an owner of a limited liability company. The subsidiary pays taxes like any other for-profit business, but the parent nonprofit's dividends are usually tax-free. A nonprofit has to move carefully as there are many ways this arrangement can go south. The IRS, for example, has held that if the nonprofit and the for-profit have identical boards of directors, they aren't really separate.
A graduate of Oberlin College, Fraser Sherman began writing in 1981. Since then he's researched and written newspaper and magazine stories on city government, court cases, business, real estate and finance, the uses of new technologies and film history. Sherman has worked for more than a decade as a newspaper reporter, and his magazine articles have been published in "Newsweek," "Air & Space," "Backpacker" and "Boys' Life." Sherman is also the author of three film reference books, with a fourth currently under way.