IRS private letter ruling 202005020 (PLR), released on January 31, addresses a multi entity structure involving a nonprofit and its wholly owned subsidiary that sought to form a political action committee (PAC). Based on the IRS's conclusions, the PLR may raise concerns for other nonprofits that utilize similar structures.
Factual Background
The nonprofit, a Section 501(c)(3) organization, was the parent of a healthcare system and provided management, consulting, and other services to its affiliated 501(c)(3) healthcare facilities and educational institutions. The nonprofit was also the sole shareholder of a for-profit subsidiary. Because the subsidiary did not have its own employees, the nonprofit and the subsidiary entered into a shared services agreement whereby the nonprofit agreed to provide the subsidiary with management, administrative, and corporate services as well as facilities and equipment. The subsidiary planned to establish and operate a PAC to solicit political contributions from employees of the nonprofit and the nonprofit's 501(c)(3) affiliates, so the shared services agreement was expanded to include the PAC. The nonprofit also leased to the subsidiary and the PAC mailing lists of the nonprofit's employees and the employees of its 501(c)(3) affiliates, all in exchange for fair market payments.
IRS Conclusions
The IRS ruled that the subsidiary's operation of the PAC would constitute impermissible participation or intervention in a political campaign by the nonprofit parent. The IRS further concluded that the nonprofit's provision of services and mailing lists to the subsidiary and the PAC would likewise constitute impermissible political campaign participation or intervention by the nonprofit. The IRS also determined that the shared services agreement between the nonprofit and the for-profit subsidiary caused the nonprofit to be operated for private interests and did not further Section 501(c)(3) purposes.
Observations
Although a private letter ruling is not precedential and not binding except on the taxpayer(s) that requested the ruling, private letter rulings nevertheless are often cited as meaningful indicators of the IRS's current thinking on issues. To that end, insofar as the PLR addresses a multi-entity structure utilizing a shared services agreement, the PLR is noteworthy for the following reasons.
First, a Section 501(c)(3) organization that participates in a political campaign risks excise tax exposure and even loss of tax exemption. In the PLR, the IRS effectively "looked through" the shared services agreement and concluded that because the directors, officers, and employees of the nonprofit parent would operate the PAC, the nonprofit parent itself would be deemed to operate the PAC. The IRS's conclusion appears contrary to prior guidance the IRS has issued regarding the establishment of PACs by affiliates of 501(c)(3) organizations. Namely, the IRS has previously ruled that political campaign activities of a 501(c)(4) organization, or a PAC established by the 501(c)(4) organization, generally will not be attributed to an affiliated 501(c)(3) organization.
Moreover, the PLR raises questions about shared services agreements in general. Many nonprofits utilize shared services agreements to efficiently staff the operations of their subsidiaries and allocate the costs of those services among the various entities. For example, a nonprofit that develops an unrelated taxable business might decide to establish a for-profit subsidiary to conduct the business. In lieu of hiring separate employees and establishing human resources and technology infrastructure for the for-profit business, a nonprofit will commonly make its employees and other resources available to the for-profit subsidiary under a shared services agreement and allocate costs between the nonprofit and for-profit entities. The IRS has issued numerous PLRs approving these arrangements and concluding that the activities of the separately incorporated subsidiary would not be attributed to the nonprofit parent. Conversely, in the PLR, the IRS treated the nonprofit as providing the services directly. Notably, in discussing the PLR, an IRS attorney recently publicly stated that the conclusions in the PLR were heavily dependent on the facts and circumstances described therein, and that the IRS was not comfortable with this particular nonprofit's representations that there would be adequate separation between the nonprofit, the for-profit subsidiary, and the PAC. Based on these concerns, in the scenario described in the PLR, the IRS chose to ignore the shared services agreement and the corporate separateness of the for profit subsidiary, such that the activities of the subsidiary and PAC were attributed to the nonprofit parent – which is ultimately impermissible for an organization exempt under Section 501(c)(3).
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The PLR emphasizes the importance of reviewing all facts and circumstances relevant to multi-entity structures and relationships between nonprofits and for-profits. The PLR further highlights that, notwithstanding the IRS's historical practice of respecting the separate status of parent and subsidiary entities, the IRS can nevertheless choose to disregard the separateness of such entities, thereby potentially implicating the tax-exempt status of nonprofits.