The npEnterprise Forum
Where Nonprofits Discuss Earned Income

None of these comments should be interpreted as legal advice specific to your organization.  For that, you should consult with your own qualified legal counsel.  Since the npEnterprise Forum is operated by volunteers, by publishing this we’re making no commitment to keep it updated as new postings arrive at the listserv.  If you need free legal assistance, go to www.powerofattorney.org.  This site includes a map of local programs that can connect you with pro bono help.  Currently this information applies to the US; we welcome additions that apply to other countries.

From the moderators, Rolfe Larson and Andy Horsnell, www.RolfeLarson.com, 5/10/06

Contents:

• How much earned income can a nonprofit generate before risking its tax exempt status?
• Is the income earned by a thrift or book store subject to unrelated business income tax?
• Are sponsorship and advertising fees subject to unrelated business income tax?
• What is private inurement – and why should social enterprises be concerned about it? 
• Is a limited liability corporation (LLC) a good legal structure for a social enterprise? 

• Should I structure my new social enterprise as a for-profit or nonprofit?

• What about nonprofit - for-profit joint ventures?

• Can nonprofits do consulting? 

• How should I structure my incubator?

• Should I set up a for-profit subsidiary? 

• What are the tax implications for paying youth a stipend for participation in an urban farm social enterprise? 

• Is there an exemption from minimum wage if certain requirements are met?

How much earned income can a nonprofit generate before risking its tax exempt status?

(1) From Jim Fruchterman <jim@benetech.org> 

Disclaimer: I am not an attorney. 

I think the question needs clarification. A nonprofit can earn 100% of its monies from earned income venture. Not a problem: done frequently.  The key issue is that there's not a problem if the earned income is from a venture that is clearly related to the nonprofit mission. 

The question that has been kicked around here is about problems when the earned income is Unrelated Business Income. And, the answer is, that there is no clear answer. I don't believe there's a regulation that you can look it up. There is no bright line. And, this is why you need an attorney who knows what they're doing if the UBI gets to be a significant part of what's funding your nonprofit, to help you assess the risks.  [Posted 3/7/05] 

(2) From Warren Tranquada <warren@tranquada.com> 

My understanding is that the % of effort can not be "significant", which is normally not more than 15-20% of the non-profit's effort. The IRS doesn't give an exact %.  Also, to clarify, this limit is not on earned income. It is on unrelated income. You can be 100% earned income if it is related to your mission.  [Posted 3/7/05] 

(3) From Michael Whitehead-Bust <mbust@comcast.net> 

There is an important distinction between related and unrelated business income in nonprofits. The danger is in having too much unrelated business income (UBI). The IRS has not issued any specific guidelines as to how much is too much. The risk is having your tax-exempt status revoked. There have been cases where more than 50% of income was derived from UBI and exempt status was upheld. From what I've read, keeping UBI closer to a ceiling of 20-25% would give you a margin of safety. I'm not aware on any similar restrictions on nonprofit business income that is deemed to be related to the mission.  [Posted 3/7/05]

Is the income earned by a thrift or book store subject to unrelated business income tax? 

(1) From Allen R. Bromberger, Esq.  

The real issue is whether the business activity contributes to the accomplishment of your tax-exempt purpose in some "important" or "significant" way other than through the production of income. If it does, the income is "related" and not subject to UBIT. If it doesn't, the income is "unrelated" and may be subject to UBIT.  

For example, if the people who work in your stores  are themselves former addicts or prisoners who are using their jobs at the store to rebuild their lives, in my view that would make the income "related" and therefore not subject to UBIT. Ditto if you are making goods available at reduced prices to former addicts or prisoners so that they can rebuild their lives. But if the businesses themselves are not run in such a way as to advance your mission in an important or significant way, but merely produce income (and perhaps visibility) for your cause, that is probably not sufficient to make it "related" business income. 

If the business income is related to your exempt purpose, it doesn't matter whether you are selling donated merchandise or reselling merchandise that you have purchased. But if the business income is unrelated, you have to be within one of the exceptions I mentioned in my earlier email, or else you may have to pay UBIT. The sale of donated merchandise is one such exception, as is income from sales by volunteers (Girls Scout cookies, anyone? 

My answers are a bit tentative, because UBIT is complicated and technical and the answer for any specific case is always in the details.  I can provide some guidance here but I really can't give legal advice in a forum like this.   [Posted 5/16/05] 

(2) From Allen R. Bromberger, Esq. 

Just a clarification on thrift stores and UBIT: under federal tax law, income from a business which is "the selling of merchandise, substantially all of which has been received by the organization as gifts or contributions," is not subject to the tax on unrelated business income. There is a similar exception for income from a business in which "substantially all of the work in carrying on the business is performed for the organization without compensation," (i.e. by volunteers.) 

Note that the standard is "substantially all" in both cases; the requirement is not absolute. And the requirement is that the items be "donated," not that they be "used." So thrift shops can sell as much new merchandise as they want, as long as it has been donated to them. There is, however, an important IRS revenue ruling which makes clear that if a substantial part of the a thrift shop's business is buying merchandise for re-sale along with donated merchandise, the UBIT exception will be lost and tax will be imposed on all sales.

This rule does not apply to college and museum bookstores, gift shops and the like, which pay UBIT on some sales and not on others, depending on whether or not the particular item is related to the organization's exempt purpose. There are special rules that cover these kinds of businesses, which Denise LeClair summarized quite nicely in an earlier post.

Note also that there may be a requirement that a thrift shop collect and pay sales tax regardless of whether the merchandise is donated or not, depending on what state you are in.  [Posted 5/12/05] 

(3) From Denise Leclair 

I am the ED of a non-profit which has a book sales program. 

I am writing in regards to what a non-profit store can sell. The crux of the problem is "Unrelated Business Income" or "UBI".  If a non-profit earns money in an ongoing activity, unrelated to its mission, it needs to be listed on a separate schedule and is subject to an alternative tax, unless it falls under one of a number of exemptions. You can do the activity anyway; the government just wants its share. 

a) Business that is intrinsically related to your mission is exempt. My organization's mission is to educate people about gender, so we can sell books about gender. We could also sell coffee cups or almost anything with our logo. Selling "Red Sox" coffee cups would be "UBI". 

b) The "Bake-Sale" Exemption is one of the most common exemptions.  Thrift shops can sell anything donated for that purpose. How much the donor can claim for that donated item is an important but separate issue. 

c) The "Girl Scout Cookie" Exemption is another common exemption for business activity conducted entirely by volunteers. 

d) Sponsorships are OK, but advertising is ALWAYS considered "UBI" (this is another complicated discussion, think PBS). 

e) BINGO is exempt if it is conducted legally, if it is an illegal activity the IRS says it is taxable, but at a lower rate. (I kid you not) 

I hope this clarifies more than it confuses.  [Posted 5/11/05] 

Are sponsorship and advertising fees subject to unrelated business income tax?

(1) From Laurance Allen   

Speaking as a practitioner and not a tax lawyer, I'd say that in my experience the answer is Yes. When I served as publisher of Harvard Business Review, part of a large 501(c), the subscription income was not taxable but all advertising revenue was taxed as unrelated business income. I believe the same holds true at National Geographic and the Smithsonian's magazine.  [Posted 6/14/05] 

(2) From Marci Waialeale Sarsona

In our case, a local car dealership has placed their logo on the doors of our leased vans. Each month the dealership cleans/washes our vans and gives us $100.00 per van (a total of $600.00 per month). We are required to pay UBIT.  [Posted 6/22/05]

(3) From Allen Bromberger, Esq.   

The short answer is "Yes." Advertising income is subject to UBIT if the publication activity is "regularly carried on," even if the publication (and even the sales activity) is directly related to the organization's mission. This rule was originally adopted by the IRS in 1993, and later codified in the Internal Revenue Code. It does not fit the general rules about UBIT, so I understand why this might seem crazy, but it is true nonetheless. 

The law distinguishes between advertising, which involves the promotion of goods and services (UBIT applies), and donor recognition, which involves a mere acknowledgement of a donor's support (UBIT does not apply). That's why ads in event journals, for example, generally don't give rise to UBIT liability. 

There are also special rules concerning the type of expenses that can be deducted against the advertising revenue for purposes of figuring the UBIT liability, and they are generally unfavorable to charities. You should get some advice on this to make sure your economic assumptions take this into account. You may, for example, decide to do the guide through a wholly owned subsidiary to get better tax treatment and protect the charity from other risks associated with the venture.

(4) From Carlos Gasca <communityatwork@comcast.net> 

A charitable gift is just that, a gift. When your client receives a service or benefit in exchange it stops being a gift and therefore it is taxable.  If a nonprofit is selling a service or product that is taxable under the general code then they must also apply such taxes to their service and follow IRS guidelines. 

From the IRS web site http://www.irs.gov/charities/article/0,,id=96102,00.html

(5) From Laura N. Solomon, Esq.  

The answers to the questions you pose are very fact-specific.  Any answers and characterizations of your various arrangements as "sponsorship," or "advertising" would truly depend on the details of each.  However, I can provide some general information, to serve as guidelines - 

First, sponsorship vs. advertising and UBIT treatment:

Under the relatively new section of the tax code (513 (i)) Sponsorship Exception to UBIT(i), certain "qualified sponsorship payments" are carved out of unrelated business taxable income. A qualified sponsorship payment to a charity is one in which the sponsor receives no more than an "insubstantial" amount of benefits in return. Once the "substantial" threshold is crossed the entire sponsorship payment becomes subject to UBTI.  If the benefits provided by the charity fall below the threshold (e.g. t-shirts, free tickets to an event), only the benefit amount is subtracted from the sponsorship payment to reduce it.   

Acknowledgement of a sponsorship payment, such as "thanks to our sponsor [name]," is fine, but any sort of qualitative statement, such as "thanks to our sponsor, the best soda in the world," renders the same sponsorship payment as advertising. Advertising must be valued as a "benefit."  The critical distinction between acknowledgement and advertising is therefore whether there are any claims or qualitative distinctions. In addition, there are separate rules that apply to exclusivity arrangements.  

Second, revenue/commissions/referral fees from affiliate relationships:

This is an area that was subject to a lot of litigation in the 90's, when the IRS challenged the Sierra Club's affinity credit card marketing program.  Royalties and other "passive" income received by a charity are exempt from unrelated business taxable income.  Therefore, if a charity shares its mailing list to a for-profit that markets products to the list members and remits a percentage fee or fixed fee to the charity, that fee would be exempt as a "royalty."  

However, here the distinction between "passive" and "active" income is critical. If the charity becomes actively involved in the relationship, marketing the products or otherwise providing administrative support, the tax treatment of the income can be jeopardized.  

There are clearly acceptable ways to structure these relationships to preserve the tax treatment of the revenue, guarantee passivity and even segregate various relationships and duties. You need a good tax/corporate lawyer to handle this - otherwise the more successful these relationships are, the more you will jeopardize your tax exemption!  [Posted 6/21/05] 

What is private inurement – and why should social enterprises be concerned about it? 

(1) From Rupert Ayton   

Private inurement relates to a couple of things. First, did the board of the non-profit do its research into the market price/value, and second, was the transaction struck at market. If the deal is a franchise deal just like any other franchise deal, it's market. The rule of thumb is to have the board review and document everything well ahead of time.  [Posted 1/20/05] 

(2) From Allen R. Bromberger   

To qualify for exemption under Section 501(c)(3) of the Internal Revenue Code, organizations have to be organized and operated "exclusively" for exempt purposes, and no part of their income or assets may be used for the private benefit of any individual. "exclusively" is defined in Treasury regulations to mean "primarily. "Therefore, whenever a charity acts in a way that serves to further the private interests of individuals or businesses rather than the legitimate interests of the charity, its tax status may be in jeopardy. The obvious and most significant qualifier is that reasonable compensation may be paid for goods provided or services rendered to the organization. 

This means that any time a charity enters into a partnership or joint venture with a for-profit entity, inurement is a concern. Franchise deals typically look like partnerships or joint ventures and therefore should structured to avoid improper inurement and protect the charity from legal jeopardy. The line between improper inurement and reasonable compensation can be a fine one, which is why I advise charities to proceed cautiously and have an attorney review the transaction whenever possible. 

There is good news, however: In general, if the business activity is designed, intended and operated primarily to further the charity's exempt purpose or its legitimate interests rather than those of a private individual or for-profit entity, or if it uses a separate entity to run the business, there normally won't be any problem. The only exception would be if the for-profit franchisor or venture partner is receiving an unreasonably disproportionate share of the revenues or profits. 

Also, inurement in this context is never a problem if both parties (franchisor and franchisee, for example) are charities.  [Posted 1/20/05] 

(3) From Steven Joseph   

Section 501(c)(3) prohibits using a tax-exempt organization for the private gain of an individual, defines a charitable organization (as opposed to religious, educational, scientific, etc.) as organized and operated primarily for charitable purposes, "no part of the net earnings of which shall inure to the benefit of any individual..."  

The concept of private inurement inherent in the organization of a stock corporation is completely contrary to an organization receiving 501(c)(3) status. Therefore, any activity undertaken by a 501(c)(3) organization that serves a private rather than a public interest is violative of the nature of a charitable organization.  [Posted 1/20/05]

Is a limited liability corporation (LLC) a good legal structure for a social enterprise? 

(1) From Allen R. Bromberger, Esq.  

I do a lot of work with LLC's as vehicles for social enterprise earned income ventures. They have certain advantages over corporations, namely that you can create more flexible governance structures and procedures, profits of the LLC are not taxed but are passed to the members as ordinary income; and profits can be distributed to members in proportions that are different than the members' percentage of ownership. The advantage of an LLC over a partnership is that the members of an LLC are generally not personally liable for debts of the LLC, including debts that arise out of a lawsuit. Depending on the type of business you are running, this can be quite important.

Be sure you are not confusing limited liability companies with limited partnerships, which are often used for financing affordable housing projects. They are two completely different animals, although they do have some features in common.

LLC's are also different from Subchapter S corporations, although they are similar in some ways.  [Posted 10/20/05]

(2) From Larry Cooney 

Our legal counsel recommended that we establish our Heroes Subs (www.heroessubs.com) catering business project as an LLC so as to protect the Bread of Life Mission. It has given the BOLM board comfort in terms of having last word on several key fronts; there are some times that becomes clumsy from a management perspective (two boards need to approve certain things) but we're learning to work through it. For the LLC to be legally effective there needs to be very clear and separate management (finances, payroll, documentation, etc...)  [Posted 10/25/05]

(3) From Allen R. Bromberger, Esq.  

A lot of 501(c)(3) organizations use LLC's to carry out social enterprises, and that is a very good option in many circumstances. As long as the 501(c)(3) is the sole member of the LLC, there is no jeopardy to the organization's tax-exempt status, and it allows the organization to protect itself from liability arising out of the business. A 501(c)(3) organization can also use an LLC for a joint venture with one or more for-profit entities under certain circumstances. The most important requirement is that the 501(c)(3) maintain effective control over the joint venture. 

I disagree that even a well-written contract is effective protection from liability. Especially when you are dealing with employment situations where the risk of litigation is always going to be high. If nothing else, you still have to deal with the cost of defense if you get sued. It's great to have good contracts, and they will reduce the likelihood of liability, but they do not substitute for a good insurance policy, or better yet, a separate business entity with a good insurance policy. A separate entity also allows you to have different pay scales and compensation arrangements from those in place at the 501(c)(3).  [Posted 10/25/05] 

(4) From Newell Lessell <nlessell@ica-group.org>  

The ICA Group has established four for-profit, social purpose staffing agencies in partnership with not for profit organizations.  We are currently working on developing an association of Alternative Staffing Agencies that seek to help disadvantaged populations obtain employment.  I would strongly recommend that you incorporate the staffing entity separately from the not for profit (even if you elect to incorporate the staffing agency as a not-for-profit).  If you are successful with the staffing you will create many more employee employer relationships (and potential liability issues) than the parent not-for-profit has.

You should also obtain appropriate business insurance and officers and directors insurance for the staffing entity.  LLC vs. C corporation will not make a difference in terms of reducing your potential exposure to liabilities.  

The LLC structure will allow you to have the entity taxed as a partnership which may or may not be of value to the parent not for profit but may be of interest if you have tax paying investors in the venture. If you expect that the entity will need to raise grant funds it may be easier to do so if the staffing entity is incorporated as a not-for-profit itself.  [Posted 10/25/05] 

(4) From Jan Cohen (JCOHENCA@aol.com)

Project HIRED has had a staffing company, HIRED TEMPS (www.projecthired.org) since 1986. It was organized, and has continued to function, as a division of the 501c3 Project HIRED with no real issues. We had Board members in the staffing industry when we began this business, as well as attorneys, who really looked at all of the potential liabilities with a fine tooth comb. These temps are your employees and your liability no matter how you organize the business.

Also, you seldom get to have "contracts" with companies. Usually they call in the temp assignment to several agencies and the first to fill it gets the "order". You may have contracts relating to price and other issues with some of the large corporations, but if there are liability clauses, you end up having these companies as "also insured" on YOUR liability policy. Initially that worried us a lot, but the "also insured", including the certificate that they require, doesn't cost very much at all.

If you do good screening and background checks, offer good prep and support to both the workers and excellent customer service to the companies at which you have temps, there shouldn't be a problem...and Project HIRED has worked with many individuals who have disabilities and backgrounds that include mental illness and substance abuse and little work history. HIRED TEMPS has been successful and profitable during most of it's 19 years history, creating work history and lots of opportunities for thousands of individuals with disabilities. [Posted 10/25/05]

(5) From Allen R. Bromberger, Esq.

Well, I can't speak for anyone else and I haven't checked the SEA database, but I know of at least one 501(c)(3) that created a separate entity to carry out a temp staffing business to protect the main work of the charity from liability. In their case, the business was different from their other programs in terms of activity, pay scale, etc. They also had a manager who wanted to run his "own" business and I think they saw the separate company as way to foster his entrepreneurial drive and give him a sense of ownership in how well the business did.

So I think Jan Cohen's response that the decision to create a separate entity or not depends to some extent on whether the venture is different from what the organization already has in place is a good observation. It also depends on what kind of advice the charity gets and whether they think the risk of liability exceeds the work of creating a new entity. There is no right or wrong answer. The most important thing is that the board do what it thinks is right based on all the information at its disposal.

At the end of the day, I think we can probably all agree with Jan's observation that the type of entity is less important than adequate liability insurance. Perhaps those of you in the business can describe what kinds of coverage you have or would advise someone to have. [Posted 10/27/05]

Should I structure my new social enterprise as a for-profit or nonprofit? 

From Sri Sridharan <infinisri@gmail.com>
I am going through this internal dialog on the same subject. I have an SE that is starting. Nonprofit? For Profit?  Here is the gist of my internal dialog. Perhaps resting on some hidden assumptions. I bare it, hoping others can shed more light on it.  I am favoring a for-profit with a governance model that is of a board of directors that has vested economic interest. But as I said I am in dialogue.

• NonProfit: Board is coming together because they subscribe to the social benefit as the value proposition. Governance in NP BOD is often weak, lackadaisical - when it comes to time or setting priorities, directors often put personal and profitable commitments ahead of their NP work. Using an NP as the container does open up to the prospect of foundation support, grants process, fundraising with tax benefits to the donors. 

• ForProfit: Board is vested in both expertise, personal economic returns in addition to commitment to the cause. Profits, however, now have to be managed so as to be benefiting the venture first. Greed has to be restrained. Guidance can be engaged, committed. People prioritize their director work in balance with personal and other profitable commitments. FP needs to raise investment capital rather rely on donors and grants.

So the balance is if we can formulate a non-greedy for-profit it would serve the cause and also yield vibrant governance for the venture.  What do you all think? Is there a hybrid structure for a non-greedy for-profit SE?

(1) From Allen Bromberger <allen@perlmanandperlman.com>
I think you have summarized the arguments pretty well, but there are also a lot of technical issues that may affect the choice of entity depending on your business model and business plan. Unfortunately, current tax law does not allow a true hybrid to exist, but there are some ways you can come pretty close. Not only can you build certain provisions into your organizational documents whether you use a nonprofit or for-profit corporation, but you can also create subsidiaries that complement each other. Even better, under a recent IRS ruling, you can combine for-profit and non-profit entities in ways that were not possible before. I use LLC's quite often for these kinds of projects, and they allow us to create non-traditional structures that suit non-traditional ventures better than "normal" corporations would do.  The idea of a "non greedy" for-profit is a bit of an oxymoron, but it is certainly possible to create one under current law. It all depends on how your business will be financed, how it wants to serve its social mission in terms of operations and governance, and what your owners expect in the way of return on investment.

(2) From Jerr Boschee <jerr@orbis.net>
So often through the years my clients have struggled with this question -- but have done so at the wrong stage.  Do you already know what type of business you will be starting?  If not, the discussion about for-profit versus nonprofit is premature.  All the points you and Jim and Cynthia make are right on the money, but the threshold question for many of my clients has been more fundamental:  Which structure does the market demand from you? In some cases, the nonprofit structure is absolutely the best one; in others, it will doom the enterprise.  And vice-versa. 

The mantra here is simple:  You have to listen the market -- and then do whatever it demands (otherwise your business will fail and the entire discussion becomes moot).  If you have already decided what type of business to start, then, before deciding on your legal structure, you'll need to look closely at the question:  What does the market demand?  And to do that effectively, you'll have to peel back two, three or even four layers of meaning to get at the root of the issues (the implications of legal structure are not always visible at first glance).  

Part of your answer will come in your long-term goals:  Will you be selling this business at some point?  Looking for outside investors?  And so on . . . At a more technical level, even if you set up a for-profit subsidiary with its own Board of Directors, the subsidiary will (in most cases) still be owned by the parent nonprofit, which retains the ultimate sanction:  If the for-profit begins to run amuck and tilt too far toward the financial bottom line (at the expense of the mission), the nonprofit parent can step in, even to the point of pulling the plug on the entire adventure.  

However, regardless of whether you structure the new venture as a for-profit or as a nonprofit, it needs to be separated as much as possible and as soon as possible from the parent nonprofit -- and steps must be taken to prevent the parent from interfering in the daily operations of the subsidiary. Successful entrepreneurship requires rapid maneuverability, and that typically doesn't happen if there are too many layers of bureaucracy.

What about nonprofit - for-profit joint ventures?

From Allen Bromberger" <allen@perlmanandperlman.com>
The first question to ask when it comes to joint ventures between 501(c)(3) groups and for-profit entities is whether the charity will have an active role in the joint venture, or whether its involvement will be merely passive. If the charity's role will truly be passive, it is probably not going to jeopardize its tax exemption, so long as the charity is receiving a fair and proper return on the use of its assets and the for-profit partner does not receive a benefit that is disproportionate to its own capital investment. There may be issues relating to whether the charity's income is subject to the tax on unrelated business income (UBIT), but that is a separate discussion that has been covered in a number of earlier posts in this forum. 

If the charity is going to have an active involvement in the joint venture, you must next ask whether the activities of the joint venture (in your case an LLC) will further the charitable purpose of the 501(c)(3). If they won't further the charity's exempt purposes, participation in the joint venture will almost certainly jeopardize the charity's tax exemption, unless the joint venture truly represents an insubstantial part of the charity's activities and the benefits to the for-profit partner are also insubstantial. 

If the activities of the joint venture will further the charitable purposes of the charity, you must then ask whether the 501(c)(3) will have  "effective control" over the joint venture sufficient to ensure that the joint venture operates to further the tax exempt purpose of the charity rather than the private interests of the for-profit partner. If the charity will have effective control (this typically means majority ownership, unless the joint venture represents an insubstantial part of the charity's activity), its tax exemption will be protected. If the for-profit partner has effective control, the charity's tax exemption will likely be in jeopardy. 

Whether or not an executive of the charity sits on the joint venture's board is not in itself determinative of anything, except that it indicates that the charity's involvement will be active rather than passive, which - applying the rules noted above -means (a) its tax exemption is put at risk, or (b) the income from the joint venture will probably be subject to UBIT. Having the charity itself as a member of the LLC is even more likely to indicate the charity's involvement is active, so that may be worse in terms of protecting the charity's tax exemption.

It is worth noting that the law in this area is changing, and the IRS has loosened the rules a bit in the past year. My sense is that the IRS realizes that joint ventures are in many cases a legitimate way for a charity to further its tax exempt mission, and - so long as the charity's interests are furthered by the joint venture, the benefits to the for-profit partners are appropriate and the charity is not and cannot be used as a vehicle for disproportionate enrichment of the for-profit partner, these kinds of arrangements will continue to be permitted by IRS. 

Note also that there are many ways for charities to engage in for-profit activity other than by doing direct joint ventures. For example, the charity can form a wholly owned for-profit (non-tax exempt) subsidiary which participates in the joint venture, which insulates the charity from liability and also protects its tax exempt status. Charities can also use financing arrangements, licensing agreements, etc. to benefit financially from for-profit ventures. Some of these approaches provide less of an upside if the business does fantastically well, but they also protect the charity from the downside of a business that fails, so they are worth considering. The key thing is that the board of the charity should consider all its options, and select the one that is best for the charity when all factors are considered. 

I deal with these kinds of situations all the time, and I strongly recommend you get the advice of a good attorney before selecting any particular form of venture, to make sure that the option you choose is the best one for what you have in mind and the interests of the charity are properly protected.   

Can nonprofits do consulting? 

From Allen R. Bromberger, Esq. <allen@perlmanandperlman.com>

501(c)(3) organizations can do consulting. Happens all the time. Just look at the Alliance for Nonprofit Management http://www.allianceonline.org   It's chock full of 501(c)(3) organizations that help other nonprofits and charge for their services. Of course, they usually call it technical assistance or capacity-building, but it is consulting nonetheless. I have done a ton of these applications and I promise you it is not an issue if it is handled properly (see next paragraph.)  As far as the description of your activities in the 1023 goes, use an IRS frame of reference instead of your own.

For example, you can describe what you're doing as conducting studies and preparing reports on topics of interest to nonprofit organizations in order to promote effectiveness in the field of nonprofit management. Or you can say you are educating nonprofit organizations about the use of technology in the field and the ways they can use technology to be more efficient and effective. Or something like that. The fact that you get paid to do it is irrelevant, especially if it is mission related. It's a false issue.   The IRS Examiner's Manual (that's what the examiners use, and it is available to the public) has many examples of exempt purposes that have passed muster; if you read a bunch of the purposes that have been approved (and those that haven't), you'll get the idea pretty quickly. There's a style to this, and it's art more than science. Experience helps a lot.  

How should I structure my incubator?

From Sam Lam" <slam@manasdevelopment.org>
We are looking to set up an incubator of sorts where we establish SE ventures. I see two options: 1) Establish multiple corporations, and 2) Establish one corporation, with multiple subsidiaries.  The second option would be more simple...less paperwork with savings on legal fees.  If the subsidiaries become more substantial, maybe we could then spin off.  Any thoughts? 

(1) From Jim Fruchterman <jim@benetech.org>
Since we [Benetech] run a nonprofit SE incubator, I would propose a third option: establish a single nonprofit corporation with multiple projects inside that corporation.  This is easier than multiple corporations: single financials and audit (but where you can zip out the performance of a venture as a project).  It's much easier to go through the IRS process once for a single nonprofit.  Only invest the effort to spin something out as a separate corporation when it's become successful and needs to become its own entity for other reasons (better fund raising, risk isolation, etc.).  If the primary goal is to set up for-profit social enterprises that are driven by the founding team, those should have their own legal entity rather than being entangled with the incubator...  

(2) From Gerald Solomon <gsolomon@phfe.org>
A third is to use a fiscal sponsor and not incur any legal or accounting or audit costs, and to insulate oneself from all risk and liability. 

(3) From Allen Bromberger <allen@perlmanandperlman.com>
First of all, I assume by a "single corporation with multiple subsidiaries," you mean a holding company, since normally each subsidiary IS a separate corporation.  Choice of corporate structure involves a lot of factors. You should make that decision only after considering the business model and making basic decisions about how you want your enterprise to operate. In other words, form follows function.  For example, the answer to your question depends on what you mean by an "incubator of sorts."

• Will you be providing startup capital?

• If so, is it debt, equity or a combination?

• Will you provide back-office or management services?

• Business planning services?

• Are you renting space to new SE's?

• Do you expect to have a continuing relationship with the new SE's, or do you push them out of the nest at some point?

• Will you charge fees? How are you going to be funded or capitalized?

• Are these all for-profit entities, nonprofits, or a combination?

• Will the new SE's be doing business with each other or will they be completely separate? 

Not to be rude, but IMHO, anyone who would attempt to answer your question based on the superficial information you've provided would be doing you a disservice.  

Should I set up a for-profit subsidiary? 

From Allen Bromberger <allen@perlmanandperlman.com>
If the primary purpose of the entity is to make money for the parent organization, without regard to social purpose except how the profits will be used, a for-profit subsidiary is probably what you want. Remember, however, that a for-profit company can generally only deduct 10% of its taxable income as charitable contributions each year, so if you are going to pay over more than that to the parent charity, the excess (i.e., dividends) will come from after-tax income.  There are ways to reduce or avoid the tax bite with a for-profit subsidiary of a 501(3)(3) organization. An LLC is always something to consider, since it is a pass-through entity for tax purposes, yet affords protection from liability. You can also use arrangements such as licensing agreements, management agreements, leases, etc. to move money from the for-profit to the charity. But you have to be careful how you set these up, or the income to the charity will be taxed under UBIT. You should definitely consult an attorney who knows about this stuff before going too far down the road. 

What are the tax implications for paying youth a stipend for participation in an urban farm social enterprise? 

(1) From Allen Bromberger <allen@perlmanandperlman.com>
I'm not surprised you can't find a precedent for avoiding taxes on stipends. Stipends are normally treated as taxable income to the recipient, although they are usually not considered salary and therefore not subject to FICA, withholding, etc.  They are typically reported to the recipient on Form 1099, not Form W-2, although that may vary depending on circumstances. You have to be careful, however; just calling something a "stipend" does not affect its tax treatment if in fact it is salary, in which case it is subject to FICA and other withholding and has to be reported on Form W-2.  The main exceptions to this rule are educational scholarships and fellowships. Take a look at IRS publication 970 for more information about those. Also, IRS publication 17 might be helpful.  

(2) From Karen L. Michaelson <kmichaelson@mail.sisna.com>
I am not a legal expert on this, but in my experience, stipends are taxable income.  But because most students make so little money, they ultimately may not have to pay taxes on this income. You need to determine your relationship to the youth.  Are they employees?  1099 contractors?  When we give teachers stipends as participants in our programs we have to send them a form 1099 each year to report the income on their taxes.

Is there an exemption from minimum wage if certain requirements are met?

The following are the emails that arrived in response to Marianne Woodward's question regarding paying less than minimum wage, for a social enterprise in Illinois that trains and employs people with criminal records.

(1) From Allen Bromberger <allen@perlmanandperlman.com>
The Federal Labor Standards Act (FLSA), which contains the federal minimum wage rules, does allow employers to pay less than minimum wage in certain, narrow circumstances. You would need to contact the Wage and Hour Division of the U.S. Department of Labor for more information about that. You also have to comply with state minimum wage laws, which may have different requirements.  Take a look at this article for some guidance. http://www.rtnda.org/members/legalnotes/legalnotes799.asp I'm not sure it still applies, however, so be careful.  A good employment attorney should be able to answer your question.

(2) From Philip Holmes <pholmes@goodwillches.org>
To pay less than minimum wages, you have to apply to the U.S. Department of Labor for an exemption and the usual reason is that the persons you would employ are not as productive as your regular workforce. You have to document this on a simi-annual basis using a performance tests in which you compare the productivity of your regular employees to those who are in your designated class getting less than minimum wage. Location isn't the issue, it's less productivity. It's so much hassle to get this done that most pay the minimum wage. 

(3) From David Weber <dweber@peakcommunity.com>
I am only familiar with two categories of persons exempt from the minimum wage: persons with disabilities employed in a sheltered setting and prison inmates. I would contact your Department of Labor office in Chicago, specifically someone in the Wage & Hour division and pose this question to them. Good luck.

(4) From Mari-Lyn Hudson <heartatwork@shaw.ca>
I am just wondering if this will be created outside prison?  How about a co-operative? For example http://www.insideart.ca is a co-operative to help prisoners to be self-sufficient. It is the first of its kind for Canada. Perhaps you could adopt this kind of model?

(5)From Judy Bailey <jbailey@iconservices.org>
The Dept. of Labor website has information on subminimum wage requirements. http://www.dol.gov/dol/topic/wages/subminimumwage.htm You can contact people at DOL directly with your questions and I encourage you to do so. Educational institutions (schools, for instance) have special circumstances which allow for paying less than minimum wage. You're right to research this fully and to be sure you are following the spirit and intent of the Fair Labor Standards Act.

I have some personal experience and opinions, which I would like to pass along, too. Feel free to consider it--or not--for what it is worth to you and your situation.  In reality, it's best to pay at least minimum wage for many reasons--ethical and economic. I have paid both subminimum and minimum wage or better (having employed individuals with disabilities in an entrepreneurial model business for many years -- benchwork model of supported employment originated at the Univ. of Oregon Specialized Training Program in the 1980s). I moved away from subminimum wages over time and will not go back to paying them. It's helpful to recognize that the performance of an individual depends in large part on the system and processes in which the work is done (if you haven't read W.E. Deming's work, I encourage you to do so). Management is responsible for the processes and so needs to accept the responsibility for setting up work processes that allow for the best worker performance. Subminimum wages remove the focus on providing all the best possible processes, supports, and training for an individual to perform at his or her peak. It encourages the supervisor to settle for less than optimum accommodations, supports, and work processes, and to see the problem of worker performance as residing within the worker rather than elsewhere. It can be comforting to mislead oneself into thinking that workers are not doing their best, but it is a trap that the manager needs to avoid. Usually they are doing their best and want to do their best, but the work setting needs to be well designed and well managed. This is not a criticism of you nor of what you are working to accomplish, but just a commentary on what I have experienced (and participated in without fully understanding it sometimes).

From another perspective, the administrative cost of completing and maintaining the regulatory requirements for time studies, recordkeeping on each individual, commensurate wage calculation, prevailing wage surveys, etc., etc. are significant and oftentimes not worth the effort. The time (money) is better spent paying at least minimum wage and focusing your efforts on the quality of training, work processes, and other issues.

You'll feel better paying people at least minimum wage, too. If the contract for the work does not allow for paying minimum wage, then you might want to reconsider or renegotiate the work crew contract. Please do not use the fact that sheltered workshops pay subminimum wages to help you justify doing it yourself. Sheltered workshops segregate people and are not focused on getting all people into full participation in their communities. Supported employment services (started in the 1980s) provide supports to allow people to work in regular businesses at or above minimum wage. Being paid less than minimum wage (and paying subminimum wage) does not help anybody's self esteem and confidence.

I hope you take this in the helpful and respectful spirit in which it is written. I write from experience. Subminimum wage is a legal (albeit administratively cumbersome) solution, but not a good one. Just say no to subminimum wages.

Judy Bailey Centreville, VA (formerly General Manager, AccuTek Assemblies, Inc.)

(6) From Joseph Barisonzi <joe@CommunityLeader.com>
Some interesting questions raised by this post. Two things came immediately to my mind:

• Is there a correlation between recidivism and the earned salary of someone with a criminal record? Earning less then a living wage - much less a minimum wage -- ensure a continuation of the poverty conditions the breed so many other problems. If the business model can not support at least minimum wage, is it the right model for a social enterprise working with those with a criminal record?

• This model - like much of the "Clinton Welfare reform" - works if there are in fact jobs to "graduate" into. Unfortunately our current economy is not blessed with a very sturdy ladder of employment opportunity, especially for people with significant challenges, like a criminal record. I fear programs that perpetuate the myth of the employment ladder perpetuating the alienation and disenfranchisement of the very people they are trying to help.

I am sure that there are ways to reframe this so that rather then finding a legal loophole to avoid paying minimum wage, the program can be part of a positive enterprise that provides support, training, and the economic means to build a stable live toward recovery, rehabilitation and contribution to society. Fundamental seems to be the identification of a felt need in the business community that can be met by the assets the target population has-a felt need that can be converted to a real living wage. Employers who have jobs that represent advancement need to be involved in the development and implementation of the program. 

(7) From Timothy Dempsey <timdempsey@comcast.net>
I run a NPO that provides reentry services to former offenders in Chattanooga and launched a staffing enterprise a couple years ago to give my clients quicker access to the workforce. We now employ the men and women we are serving through contracts we have established with local employers for temporary/permanent jobs -- all of which pay more than minimum wage. Former offenders have a wide range of needs when they attempt to rebuild their lives after a prison sentence and many of these needs disappear with a living wage. This is not to minimize concerns about mental health, substance abuse, family systems, education, etc; however there is a clear correlation between earnings and recidivism.  Jobs keep people out of jail, but not just any job. Former offenders need to see their job as an asset that they don't want to loose (decent wages, benefits, reputable company, room for advancement etc) before it has the ability to help change behavior. 

Judy is exactly right. Just say no to minimum wages. Low wages speak loudly about how we see the value of our clients and can have a devastating effect on an organization's reputation, not to mention its competitive position in the market.  Because of our tax status and other benefits of being a NPO we could provide our labor at a fraction of the cost of our competitors and still make money. We don't do that for many reasons including the fact that we would be advertising that we believe that our labor is inferior to that of our competitors' -- when, in fact, it is not. 

To compete you have to do it better, faster or cheaper -- but be careful on the cheaper position. It's not as simple as under pricing your competition.

Timothy Dempsey Chattanooga Endeavors, Inc. Chattanooga, TN http://www.chattanoogaendeavors.com

(8) From Marianne Woodward <Mlwchasi@aol.com>
Thanks to all those who have responded to my original question. In an effort to keep that initial post brief, I may have created a faulty impression, so would like to clarify: 
    The organization that I am working with has the goal of helping people with criminal records re-establish themselves, and to successfully re-enter their communities (and to NOT re-enter prison). The goal is to help them achieve, and maintain, employment where they earn enough to support themselves and their families, to have benefits, and the opportunity for career advancement. 
    One mechanism, which has seemed to facilitate this, is a transitional job program. This is a program designed for people who have just left prison. It is designed to be short term in nature (90-120 days). It is designed to have people have something constructive to do immediately after exiting prison, to get them some earnings, to help them develop (or refresh) the soft skills necessary to be successful in the long term work place, and to allow them to develop a job reference (some have never been employed). While in the transitional program, the individuals are provided extensive supports (counseling, job coaching, etc) and also economic supports (clothing, transportation, food vouchers equivalent to multiple dollars per hour). This more supportive transitional environment allows the participants to make the transition to the workplace in a more forgiving environment. 
    But to ask mainstream employers to work with our clients (which is our goal), where we promise high turnover, and acknowledge that the work force may have some rough edges, we need to offer something in return. One avenue we are exploring is the idea that we might be able to lower the employers' costs. These positions are de facto positions that pay the minimum wage (needs to be very low skill low training needed to work for a transitional job program), so the one way to reduce costs is to see if the wages can be below minimum wage.
    The goal and plan is for this program to be a short term stepping stone to meaningful employment. To give people time to get themselves together to pursue and obtain a job that does pay a living wage.
    So my question about the minimum wage requirements and possible exemptions relate to this transitional program. We do not want people to stay in these jobs, nor should they. These are to train them to be able to obtain, and maintain, a livable job, in a short time frame.
    Hope this allays some of the concerns I heard about exploitation of the people we serve. It's quite the opposite of that.

(9) From Larry Cooney <larry@breadoflifemission.org>
This is what we are trying to do with Heroes Subs http://www.heroessubs.com . I think it would be attractive to pay the program member's wages with his post-program employer for a period of 30-90 days. I notice this is what some Work Source type programs do. 

(10) From Dick Dillon <ddillon@pfh.org>
Our organization has grappled with this issue as well. On the one hand we want the people we serve (graduates of substance abuse and mental health rehab programs, often re-entry folks from corrections) to have a meaningful job with a living wage. On the other hand, it takes a lot of money and/or other resources to train people, but the training itself has an economic value.  It sounds like your approach is the one we favor as well, involving a reduced (even under minimum wage) stipend during training, advancing to minimum wage once initial training is complete, and increasing to a good living wage once some period of time of consistent employment/performance (we look at six months as representative) has been established.

(11) From Timothy Dempsey <timdempsey@comcast.net>
This is a pretty typical program design that has been around for a long time and has helped many former offenders transition from prison to the workforce. Given the nature of this forum - i.e., to discuss income-generating business activities for NPOs - it is not unreasonable to have assumed that your concept also contemplates a revenue stream. From what you say here, it appears that it may not; which changes things quite a bit. There are stunning models of social enterprises that have created substantial revenue streams with former offenders as a workforce. Pioneer Human Services, and Delancey Street Foundation to name just two. My question to you is why would you prefer your transitional work model to the earned income strategies that have done such remarkable things for so many people? (This is not rhetorical. I'm interested in your reaction.)
    When you say, "to ask mainstream employers to work with our clients (which is our goal), where we promise high turnover, and acknowledge that the work force may have some rough edges, we need to offer something in return" - I would suggest to you that you already are giving something to them in return. It's a tough sell to begin with, but my experience has been that once they are sold they keep coming back. With my staffing agency for former offenders, our show-up rate is the best in town, our workers are better screened, better trained and better supported than those of any other agency (we invest over $2,000 in each worker before sending him/her on an assignment) and our customers are more satisfied with our performance and this all at a competitive (not subsidized) rate.

(12) From Jerr Boschee <jerr@orbis.net>
I've been following with interest the discussion about minimum wages for ex-offenders and would like to hear any thoughts from people on the listserv about "commensurate wages" for people who are developmentally (intellectually) disabled.
    Some nonprofits start businesses to employ people who are developmentally disabled and pay them on the basis of their productive capacity. In other words, they sit down with the individual at the beginning of his or her employment and do an analysis of their capabilities. They then find a task the person can perform. It may be a very simple task and it may mean the person can accomplish only about one-fifth of what a person who is not developmentally disabled can accomplish. The nonprofit then pays the person at one-fifth the market rate for the non-developmentally disabled person. Doing so enables the nonprofit to compete in the marketplace. The persons' salary, of course, goes up as his or her productive capacity rises.
    Other nonprofits resist this approach and instead insist on paying their employees who are developmentally disabled the same wage as other employees. Needless to say, this places a very large burden on the business itself because it is paying for productivity that it is not receiving.

(13) From Bob Lutes <lurob12@yahoo.com>
Although I have had limited experience with this issue of commensurate pay, I think that you are right on the money to bring up the issue.  My experience dates back to 1982, while employed as the contract development manager for the Association of Retarded Citizens Fresno. The experience there was one that I found very rewarding as the most fundamental aspect of their entire program in their "Production Center" as the understanding that was there and so greatly accepted by the clients there was the instilling of the "work ethic".  The clients were paid on their capacity to produce and always paid fully upon their production output.
    The method of calculation used to arrive at the pay rate was that the staff would simply determine what each of their team members could do on any given item that was to be produced in an hour's time and then they would take an average and divide these units of production into piecemeal work. This then was the DOL acceptable form of payment.
    I think that the best experience that I had was when I was witness to the exuberance and excitement of a man who received his paycheck for twenty-five cents. He was happy (I think) because he knew that he had "earned" that money himself. And was fully compensated for the amount of work that he could produce. Of course every situation was different but that was the foundation of the pay scale for these people.
    My recommendation to you would be to contact the nearest ARC-- Association of Retarded Citizens, which is a nationwide group that went by the acronym of ARC; and ask how they do theirs today.  (Bob Lutes, Executive Director Valley Housing and Economic Development Corporation Fresno, CA 559-271-3092, DBA: Valley Affordable Housing)

(14) From Timothy Dempsey <timdempsey@comcast.net>
Certainly there are reasonable justifications for sub-minimum wages for workers with serious mental or physical disabilities; not many people would argue with that (especially if higher wages would jeopardize an enterprise's margin). On the other hand, if an organization has an enterprise with a big contribution margin but pays its workers sub-minimum wages, I would challenge its board for profiting on the backs of its clients. Good businesses share their profits with their workers. NPO enterprises should be no different.
    I like the question, however. It brings up a concern that I have heard many times about NPO enterprises - i.e., that they exist to relieve the organization from other more conventional methods of charitable fundraising. If enterprise income makes it easy for us to forfeit an event, grant or gift we are not being good stewards of our resources, and we are not being good managers of our enterprises.
    At the end of the day, our clients need to be better off for their association with us. That should drive our strategies. The question of subsidized vs. sub-minimum wages for clients with serious disabilities is a deeply personal one for organizations that address these issues. Where the workers are able (in the conventional sense) the question seems to me to be rhetorical.