Q&A #95 – Can nonprofit parent and subsidiary organizations have identical Boards?

Question: I am the Executive Director of a local 501(c)(6) chamber of commerce that is planning to form a subsidiary 501(c)(3) organization to carry out education and other charitable programs. We want to make sure that the two organizations are closely aligned. Is it possible for the new 501(c)(3) organization to have the same Board members as the chamber?

Answer: There is not a cut-and-dry answer to the question of whether nonprofit parent and subsidiary organizations with different tax-exempt statuses are permitted to have identical Boards. However, too much Board overlap could potentially increase the risks that one or both organizations will be perceived by the IRS to be violating the restrictions on their tax-exempt status. In the case of a parent 501(c)(6) chamber of commerce with a subsidiary 501(c)(3) organization, it is generally advisable to have at least one or two persons on the Board of the subsidiary who are not Board members of the parent.  

The overlap of Board members raises a couple different issues.

First, if the IRS determines that a parent organization is so thoroughly in control of the day-to-day operations of its subsidiary organization that the subsidiary is merely an “arm, agent, or integral part” of the parent, the IRS will disregard the separateness of the entities for purposes of their tax exemption. It is rare for the IRS to reach this conclusion, but it has happened in extreme cases.

While having identical Boards will not necessarily lead to this determination in the absence of other unfavorable factors (such as having identical officers and failing to maintain separate books and records), it is helpful to have at least some independent persons on the subsidiary’s Board and/or different persons in lead officer position (e.g., President) to help show that the entities are indeed separate and governed by their own leadership.

Second, and perhaps more importantly, related 501(c)(6) and 501(c)(3) organizations often need to share staff employees, office space, and other resources. It is common for the subsidiary 501(c)(3) organization to reimburse the parent for its reasonable share of these costs. However, as we've previously explained, these cost sharing arrangements must be carried out pursuant to arm’s length agreements that ensure the 501(c)(3) organization does not pay more than fair market value. Such arrangements tend to be highly scrutinized and implicate important 501(c)(3) tax principles (for example, the private benefit rule). Therefore, having formal agreements in place and following clear and transparent processes is of the utmost importance.

For these reasons, it is generally recommended to have some independent persons on the subsidiary’s Board to carry out due diligence, review and approve the terms of the arrangement, and periodically check to ensure the subsidiary is not being over-charged or charged for services or resources that it does not use.

Planning Tip – When forming a subsidiary organization, always make sure that the subsidiary has a clear set of bona fide programs and activities that are distinct from the parent. This is especially true in the case of related 501(c)(6) and 501(c)(3) organizations. The failure to maintain programmatic and operational boundaries is a frequent cause of confusion that can lead to disputes, compliance issues, and other problems.

The issues and risks raised by the overlap of Board members vary widely depending on the particular facts and circumstances, and numerous different approaches to Board composition may be possible.  Make sure to consult with your legal and tax advisors to find the approach that will best achieve your goals while presenting an acceptable risk.

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