Tax exempt organizations often enter into relationships with other organizations that are collaborative in nature rather than merely quid pro quo. These relationships are frequently referred to as “partnerships” by tax exempt organizations because the connotation is one of teamwork and working toward a common goal. However, under state law, entering into a “partnership” can result in a host of liabilities that none of the “partnering” organizations intend. In addition, if one of the partners is a for-profit entity, the partnership could jeopardize the federal tax exempt status of the tax exempt organization.
If two or more parties join together for a common business purpose, they may create a general partnership under the laws of the state in which they are conducting that business. “Joint ventures,” which are generally limited in scope to a specific project, may be considered general partnerships under this theory, as well. By calling the relationship between two organizations a “partnership,” the participating organizations could be establishing a presumption, at least to the general public, that they are operating as a general partnership. The problem therein is that, in a general partnership, any general partner can bind the partnership and each general partner is jointly and severally liable for the debts and obligations of the partnership. Thus, in an effort to be collaborative, a tax exempt organization could inadvertently subject itself to the unsupervised activities of its partner. It would be possible to rebut the existence of a partnership based on the argument that the organizations were not “conducting business,” however the inference created by referring to the relationship as a partnership and the potential cost of having to litigate that position make the problem easier to avoid than fight.
In addition to the liability concerns of creating a general partnership under state law, if the partner is a for-profit entity, then the problems can compound at the federal income tax level. Any partnership with a for-profit organization can be dangerous and the agreement should be carefully reviewed for compliance with tax exemption requirements. The activities of a partnership are imputed to its partners for federal income tax purposes. Thus, adequate procedures must be in place to ensure that the activities of the partnership further the exempt purposes of a tax exempt organization partner. Furthermore, the partnership agreement needs to be drafted to ensure that the tax exempt partner has sufficient control over the partnership to ensure that the partnership’s activities continue to further the exempt purposes of the tax exempt partner and do not allow for any impermissible private benefit or private inurement. See IRS Rev. Rul. 98-15, 1998-1 CB 718 and Rev. Rul. 2004-51, 2004-22 IRB 974.
Before entering into a “partnership” with another organization, assess the goals of the relationship. Although two (or more) organizations may view a short- or long-term collaborative project as a partnership, a tax exempt organization should evaluate exactly what it is seeking to give and receive with respect to the project, and determine whether there is a more efficient legal structure for the relationship. For example, if the tax exempt organization is providing funding for a project and another organization will be performing services relating to the project, then a services agreement with specific project deliverables and set compensation at fair market value may be a better option than a partnership or joint venture agreement. If the tax exempt organization is assisting another nonprofit organization in obtaining a bid for a project in exchange for the right to participate in the project, then a strategic alliance agreement may be a good option, where the mutual benefits and obligations of the contracting parties are set forth, but there is no “business” being operated by two partners in a partnership. As a final example, if a tax exempt organization wishes to manage some or all of the activities of another not for profit organization without acquiring the other nonprofit organization, the tax exempt organization could enter into a management agreement with respect to such activities, where the services could range from administrative service support to full management services, with fair compensation for such services set forth in the management agreement.
If the relationship between the parties is not a partnership, whether it is legally structured as another type of relationship as described above or is an informal collaborative arrangement, tax exempt organizations should avoid “partnership” or “joint venture” language if there is no partnership or joint venture, as legally defined. There are other terms that connote a cooperative relationship that do not carry the legal baggage of holding yourself out to the public as a partnership, e.g., collaborative agreement, strategic alliance agreement, cooperative agreement, and affiliation agreement.
