Nonprofits eye corporate structure to dodge IRS reporting rules

Nonprofit lawyers are advising clients to consider a strategy that would allow them to use losses to offset their organizations’ taxable income, after the IRS proposed changes to reporting rules.

In April, the IRS proposed rules that require sole proprietorships controlled by nonprofit organizations to report income separately. This practice, known as ring-fencing, changes a nonprofit’s ability to use net operating losses (NOL) from one business to another to reduce the overall tax payable by non-profit organizations.

As a result, some tax lawyers suggest that their nonprofit clients set up C corporations within their organizations to combine these unrelated lines of business and avoid the silo requirement. The idea comes as nonprofits like trade associations, colleges, universities and hospitals scramble to get money from all available sources as the coronavirus pandemic wreaks havoc on economies. American and global.

Under a C corporation, nonprofits could merge different lines of business and report the revenue they generate in a single report, avoiding silo rules and, more importantly, taking advantage of tax breaks for NOLs that are currently accumulating.

The IRS allows nonprofits to aggregate NOLs across silos generated before 2018. But the agency directs them to separate NOLs based on each corporate silo occurring in tax years after 2018, according to the FAQ published at the beginning of June.

“If they generate losses now, these will remain siled unless they are generated in a C corp. which is not subject to these silo rules,” said Ofer Lion, partner at Seyfarth Shaw LLP. .

Upcoming challenges

Establishing a C corporation, however, comes with its own potential regulatory pitfalls. It must have a board of directors and bylaws, as well as plans for overhead costs and limitations on deductions which may make the option unattractive to smaller nonprofits with less money.

But for large nonprofits that already have a C corporation under their wings, adding non-related businesses to that entity for tax benefits can make sense.

Lion said some universities that already have a corporate subsidiary in place are considering moving unrelated companies into that organization.

Under a C corporation, the merged companies would have to share accounting costs that would be “unavoidable”, Lion said.

“You talk to the CFO or the treasurer, and they’ll quickly remind you that there’s a lot more cost and work involved,” Lion said. “You install the thing, it takes you a few days, and then I have to deal with this thing for the rest of my life – that’s their point of view.”

Christopher Moran, a partner at Venable LLP, said his team has been offering the C corporation structure to clients since the proposed rules were released.

His advice to clients: Consider this option carefully as there is a risk of losing tax-exempt status on many activities, which could cause more problems than benefits.

The idea has attracted interest from some customers, he said, but most have refused to pull the lever because the rule is still at the proposed stage and provisions may change. He also said it’s likely nonprofits will wait a few years to apply the silo rules to see if they need to change their tax strategies.

“Maybe in a few years, when they’ve done a few more tax returns applying the silo rules, they could think of ways to simplify the filing process,” Moran said. “But that probably hasn’t been a priority for a lot of customers.”