Is Your Nonprofit Entering a Joint Venture? Beware of Tax Planning Considerations

Nonprofits may consider a joint venture for a variety of reasons, ranging from taking advantage of investment vehicles to joining with other entities (including nonprofits) for operational enhancements. The joint ventures, or partnerships, can provide opportunities for a nonprofit to enhance or accelerate its ability to fulfill its mission.

When entering any form of joint venture or partnership, a nonprofit must be careful to consider the potential, and sometimes significant, tax implications these relationships can bring.

In addition to the consideration of whether these relationships generate Unrelated Business Income, which generate a tax liability for the nonprofit, there are also compliance issues to consider. Understanding these before officially entering into any form of partnership or joint venture (JV) is vital. 

In the following overview, we dig deeper into these opportunities and how to ensure your nonprofit stays in compliance when entering a JV.

Key Factors to Consider Before Establishing a Joint Venture

Even before tax considerations, nonprofit leaders would be wise to start by evaluating the optics of any potential partnership. Undertake due diligence and ensure your organization does not partner with an entity that conflicts with your mission. It’s also advisable to steer clear of political issues: if a tax-exempt organization aligns itself with a political party, its 501(c)(3) status may be at risk. 

Investing in a Partnership: Key Tax Considerations

When choosing to allocate some portion of the organization’s capital to a new investment vehicle, there are several tax considerations that nonprofits must keep in mind:

• Unrelated Business Income Taxes (UBIT): some investments may result in Unrelated Business Income. This isn’t necessarily a bad thing: your organization will only owe UBIT if it has made money. However, leaders should understand ahead of time whether investment returns will result in UBIT. One common UBIT trigger is income generated by investments in debt-financed properties: such as income from a typical real estate investment fund. Organizations should also confirm they will receive a Schedule K-1 reporting the income from the partnership. 

• State Tax Nexus: if the partnership your organization is investing in files state tax returns in states where your organization currently does not have a state income tax nexus, establish whether your investment will result in your organization having nexus in new states. If so, make sure to budget for additional filings and compliance costs. 

• International Filing Requirements: some partnerships may invest in international assets, which could expose your organization to international tax filing requirements. Verify the information you will receive and identify the tax filing requirements this may create. This is an important issue: penalties for non-compliance with international filing requirements can be as much as $10,000 per incomplete filing. 

• Tax Leakage: establish how the organization you invest in will be taxed. Partnerships are flow-through entities, meaning that their income is taxed at the partner level, not the corporate level. This means that you, as a nonprofit organization, will effectively pay more taxes on your investment returns. Consider this when assessing the potential rate of return of an investment. If an entity you invest in is organized as a corporation, it will pay the 21% corporation tax. The nonprofit, as an owner of a corporate entity, will generally not pay tax on investment distributions from a corporation.  

Organizations must weigh these tax considerations before making an investment since these will often influence their overall judgment of the strength of an investment. 

It’s important to remember that tax is just one input in the decision-making process. It may be the case that a certain investment will produce both UBIT and new filing requirements, but if it’s a highly promising investment, it may be worth these additional costs. 

Proactively considering the tax impacts of proposed investments is key to being a wise steward of your organization’s capital. By taking a proactive approach, organizations have ample time to plan for additional filing requirements and to work with their tax advisors to create a plan to offset any potential UBIT. 

Entering a Joint Venture for Operational Purposes

Not all partnerships a nonprofit organization engages with will be investment vehicles. In some instances, a tax-exempt organization might choose to partner with another entity for more operational reasons. For example, a local art museum might partner with an educational nonprofit to provide art lessons to children in local schools.  

In these instances, there are additional considerations that nonprofit leaders should weigh before entering any partnerships. These considerations may result in additional tax planning requirements, depending on the nature of the relationships. 

• Receiving Benefit for Services: if an organization receives a benefit for services it provides to another entity through a partnership, it may be required to quantify the value of these services and report the benefit on Form 990-T.

• Related Entities: if an organization has related organizations or has conducted significant activities through unrelated partnerships, they may be required to file Form 990, Schedule R. This is an added compliance responsibility, but it is also important for organizations to consider the optics of their relationships with related entities and ensure that these are not to the detriment of the organization, donors, or those benefited by the mission. 

• Conflicts of Interest: conflicts of interest often emerge when an organization engages in a relationship with an external entity that a board member, officer, or senior member of the organization is a senior member of or has significant influence over. Any conflicts of interest must be disclosed on the organization’s Form 990. 

• Sponsorship vs. Advertising: qualified sponsorship income is not considered UBI, whereas advertising income is. Nonprofit leaders must scrutinize their contracts and determine whether any sponsorship relationships meet the criteria to be considered taxable advertising income. It’s always advisable to have all partnership contracts reviewed by a tax professional.

Smith + Howard: Sophisticated Tax Planning + Compliance for Nonprofits

Entering new relationships––whether they’re investments, project-oriented associations, or operational partnerships that extend your organization’s reach––can have significant tax implications. In any decision related to partnerships or joint ventures, an organization should ensure that its overall tax-exempt status is protected and it is still primarily focused on achieving its tax exempt mission.

If your nonprofit is considering a partnership approach, it is important to proactively consider the tax implications. The fact that a partnership has tax consequences does not necessarily make it a bad partnership. At Smith + Howard, our nonprofit tax professionals are well-equipped to help organizations evaluate the tax consequences of partnership opportunities. With our support, organizations can develop a sophisticated tax plan that weighs the tax considerations of different investment vehicles and partnerships. 

If you’d like to engage with our nonprofit team for advice in this, or other matters specific to your nonprofit, please contact us today.