[NEohioPAL] Filmmaking as part of a Nonprofit Organization - Installment V. Alternative Business Structures

[Mary Ellen Tomazic]

         Current tax law allows a tax exempt organization to conduct
unrelated business activities through a for-profit taxable subsidiary.
The reasons for forming such a business structure are not always
tax-related, but are used to adopt compensation arrangements, employ
different management structures for its various activities, to avoid
disclosure of sensitive financial information or protect the exempt
organization from the liabilities of the business activity. Tax
considerations may also play a role in the decision, because dropping
the taxable activity into a for-profit subsidiary may protect the
exempt organization from challenges to its exempt status.[1] As long
as the two entities are kept separate, the identities of the exempt
and the controlled subsidiary are almost always respected by the
Internal Revenue Service. The activities and income of separate
controlled entities generally are not taken into account when
determining whether an organization’s “primary purpose” is a tax
exempt purpose, at least if the parent does not exert day-to-day
operational control over the subsidiary’s activities.[2]

        Taxable subsidiaries are sometimes used to serve as the
general partner when an exempt organization engages in a joint
business venture with for-profit entrepreneurs and investors. Joint
ventures between nonprofit and for-profit entities provide an
alternative for the nonprofit to advance their mission while
eliminating total reliance on more traditional sources of funding.
They also allow the nonprofit to benefit from the managerial expertise
of their for-profit partners. The Arts is one of the principal areas
in which joint ventures have been employed, and Broadway plays often
use the limited and general partner structure.[3] More recently,
limited liability companies have been the vehicle of choice, though
some of these structures attract attention from the I.R.S.

        The test of charitability and private benefit, where the
participation of the nonprofit furthers its exempt purpose and permits
the charity to operate exclusively for exempt purpose and not for an
impermissible private benefit, was developed from the case of
Plumstead Theatre Society, Inc. v. Commissioner.[4]As one of a variety
of planned activities to promote the arts, a nonprofit theater company
served as a general partner in a limited partnership to co-produce a
play. The theater company contributed a portion of its intellectual
property rights in the play in exchange for a 36.5% profit and loss
interest in the partnership. The limited partners contributed $100,000
cash for the remaining 63.5%. The Tax Court held that the purpose of
the joint venture was to raise capital to further the theater’s exempt
purposes, and it did not cause Plumstead to be operated for a private
rather than a public purpose. The court set out three factors that
controlled its decision: 1) the theater as the general partner
controlled the venture; 2) it was only one of many different
activities engaged in by the theater, and 3) none of the limited
partners of the joint venture was an officer or a director of the
theater society.[5]

        Some joint ventures are conducted through less formal
contractual arrangements such as joint operating and licensing
agreements. These forms are less protective of the nonprofit
organization, but may suit its purposes as long as the transactions
are at arm’s length and do not serve private interests. The same test
for charitability set out above controls in these situations.[6]

        So if the ministry in question uses a separate for-profit
subsidiary to conduct its for-profit YouTube advertising business, it
may retain its tax exempt status and avoid liability from the business
activities. If it forms a joint venture with a for-profit company, as
long as it controls the venture and it is only one of the various
activities it is engaged in and the venture furthers its exempt
purpose, it should not jeopardize its tax exempt status. The tougher
requirement in this case may be the fact that the for-profit company
may contain persons who are an officer or director of the ministry,
giving the impression of a conflict between the service of the
charitable purpose and the private interests. Any business transacted
by a nonprofit, whether in a joint venture with a for-profit business,
or as an unrelated business of its own, will most likely require
payment of taxes on that income, so the benefits and burdens of each
structure must be researched and seriously considered before the
activity is conducted. A caveat to this analysis is that it was
reached through the study of Internal Revenue Code and Treasury
Regulation sections, pertinent federal cases, and the writings of
legislators and experts in the field. It is wise to seek the advice of
a tax professional before deciding on a business structure that
involves the utilization of a §501(c)(3) nonprofit organization’s tax
exempt status as part of the funding of a film or other artistic
creation, even if the film directly “exploits” the same function as
the nonprofit. I have tried to give filmmakers an overview including
actual case examples of this type of funding, so they can consider its
benefits and drawbacks in their decisions.

  © 2012 Mary Ellen Tomazic

Mary Ellen Tomazic is an attorney in Cleveland specializing in
entertainment issues such as copyright, trademarks, contracts and
licenses for musical groups and filmmakers.


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[1] James L. Fishman and Stephen Schwarz, Nonprofit Organizations
Cases and Materials 709-710 (3d Edition 2006).

[2] Id.

[3] See generally Mary Ellen Tomazic, Limited Liability Companies for
Films (2011).

[4] 74 T.C. 1324 (1980), aff’d per curiam, 675 F.2d 244 (9th Cir. 1982).

[5] Id.

[6] Rev. Rul. 98-15, 1998-1 C.B. 718, discussing the activities of a
partnership including participation of an LLC, stating that the
participation of the exempt organization in the partnership still
allowed it to further its charitable purpose, and only incidentally
benefitted the for-profit partners.