Related Foundations: Is Your Association Avoiding the Legal Pitfalls and Maximizing Its Opportunities?

One of the most useful planning tools available to trade and professional associations is the use of related educational, charitable and scientific foundations. For a variety of important reasons, associations for years have established and operated related foundations. Properly utilized, such foundations can reap enormous benefits for associations and the industries and professions they represent. At the same, though, the legal terrain in which they operate is fraught with hidden traps and pitfalls.

The vast majority of associations that operate related foundations are neither effectively sidestepping these pitfalls nor maximizing their opportunities to generate revenue and cut costs. This article is designed to provide association executives with a practical, legal road map to this area of tremendous opportunity and potentially significant risk for associations.

Reasons for Establishing Related Foundations

Approximately two-thirds of all trade and professional associations are exempt from federal income tax under Internal Revenue Code Section 501(c)(6). While some associations are exempt under Section 501(c)(3) - and are thus able to capitalize on certain advantages available exclusively to 501(c)(3) organizations - the majority of associations do not qualify for the coveted 501(c)(3) status. What many associations learned years ago, however, is that is often possible to avail themselves of such advantages indirectly, through the creation of 501(c)(3) affiliated organizations (often called "related foundations").

Only 501(c)(3) organizations are eligible to receive tax-deductible charitable contributions (501(c)(6) organizations can receive dues or other payments that will be deductible to the payor only if they serve a business purpose of the payor); receive many federal and state government grants; and qualify for nonprofit postal permits (enabling utilization of significantly-reduced nonprofit postal rates). In addition, only 501(c)(3) organizations are eligible for many state and local sales and use, real estate, and other tax exemptions (in many jurisdictions, only certain categories of 501(c)(3) organizations are eligible for certain state and local tax exemptions); able to receive private foundation grants without the private foundation having to exercise "expenditure responsibility"; eligible to issue tax-exempt bonds (providing for significantly lower financing costs); eligible to receive tax-deductible gifts of property; able to commence a deferred giving program with the ability to enter into charitable remainder gift arrangements, provide charitable gift annuities, and have a pooled income fund; and able to maintain a charitable bequest program for federal gift and estate tax purposes (whereby individuals are encouraged and enabled to make some provision for support of the organization as part of their estate plan).

For some or all of these reasons, many 501(c)(6) associations establish 501(c)(3) related foundations.

The funds raised by a related foundation must be used for educational, charitable or scientific purposes, but very often, the "parent" association is already carrying on significant educational, charitable or scientific activities which can be shifted to the related foundation. It is very common for associations to operate related foundations which raise funds; sponsor research; stage educational seminars and conferences; publish journals, books, studies, and other educational and scientific publications; award grants and scholarships; and conduct other educational, charitable and scientific activities that benefit the industry or profession represented by the association.

Qualifying for Public Charity Status

Qualification for tax exemption as a 501(c)(3) organization is contingent primarily on the fact that the activities of the related foundation will be principally educational, charitable and/or scientific in nature. In the association context, this test can generally -- but not always -- be satisfied with relative ease. This is a very fact-specific determination. Frequently, a key factor is establishing that the activities of the related foundation will benefit the general public (or at least a relevant segment of the general public) -- and not merely the related association and its members. This is an area deserving of careful scrutiny and planning as a related foundation is conceived and as the governing documents and tax-exemption application are prepared.

The tax-exemption application process has a second component, however -- qualifying as a public charity in order to avoid (the undesirable) private foundation status. There are three ways to qualify as a public charity. Most related foundations, however, qualify for public charity status as "supporting organizations" (under Section 509(a)(3)). A supporting organization is an entity which is: 1) organized, and at all times thereafter operated, exclusively for the benefit of, to perform the functions of, or to carry out the purposes of, one or more public charities; 2) operated, supervised or controlled by or in connection with one or more public charities; and 3) not controlled directly or indirectly by one or more disqualified persons, other than foundation managers and other than one or more public charities.

A section 501(c)(4), (c)(5) or (c)(6) organization, which would qualify as a "publicly-supported charity" under section 509(a)(1) or (a)(2) if it were a section 501(c)(3) organization, is permitted to establish a supporting organization. This means that a related foundation will qualify as a supporting organization if its parent association "normally" receives (i) at least one-third of its total annual revenue from government grants and/or contributions made directly or indirectly from the general public, or (ii) more than one-third of its total annual revenue from government grants, contributions, membership fees, and program service revenue (i.e., from activities related to its tax-exempt functions) and no more than one-third of its total annual revenue from gross investment income, rents, royalties, and unrelated business taxable income. Most associations satisfy the requirements of the latter test.

Related Foundation Activities

A related foundation may engage in many activities related to the parent association's industry or profession, including publishing, seminars and conferences, research, grant-making, scholarships, fellowships, and awards, among other activities. These activities are ones either previously undertaken by the association or initiated by the related foundation, or both. The related foundation's activities can be funded by gifts, grants and program service revenue (e.g., publication sales, conference registration fees), leaving the association's revenues (e.g., membership dues) to support the remaining association programs and activities.

It is important to note that "educational" activities need not be educational to the entire public; they can educate a special segment of the public, such as members of a particular trade or profession. However, the educational programs carried on by the related foundation cannot be limited to members of the parent association (the programs can focus on the interests of such members, but access cannot be restricted to association members). If individuals who are not association members attend educational seminars or conferences sponsored by the related foundation, the association may create an opportunity to solicit new members.

The Association-Foundation Operational Relationship

As with any relationship an association maintains with an affiliated entity, strict financial, management and operational separation must be maintained between an association and its related foundation at all times. The separate corporate existence of the related foundation will be disregarded by the IRS or the courts -- with tremendous adverse consequences for the association, the foundation, and foundation donors -- if the parent association controls the affairs of the related foundation so pervasively that the foundation becomes a "mere instrumentality" of the parent. This will occur if "the facts provide clear and convincing evidence that the [foundation] is in reality an arm, agent, or integral part of the parent [association]."

IRS rulings and court cases in this area also indicate that no one factor determines whether an affiliated entity will be respected as separate. Instead, the IRS and the courts will consider several different factors and reach a conclusion based on their significance taken together. These include whether a valid purpose exists for forming the affiliated entity; whether the parent is involved in the day-to-day management of the affiliate's affairs; the extent to which the two entities share directors, officers and/or employees; and the extent to which the two entities share facilities and/or services.

However, unlike an association's relationship with a taxable subsidiary or other types of affiliated entities, when the affiliated organization (i.e., related foundation) is a section 509(a)(3) supporting organization, as discussed above, more control by the parent association is not only permitted, but is required. In practical terms, while this does not obviate the need to maintain strict financial and operational separation between the entities (to avoid a finding that the foundation is a "mere instrumentality" of the association, with the result being the disregard of the separate corporate status of the foundation), more overlap between directors and officers, for instance, is permitted. As section 509(a)(3) requires that the related foundation be "operated, supervised or controlled by or in connection with" the parent association, the IRS cannot credibly contest the presence of some common directors and officers. However, this is a narrow and often ambiguous line which must be carefully negotiated by associations and their related foundations.

Association Contributions to the Related Foundation

As a general rule, a parent association may make virtually unlimited contributions -- without consideration -- of cash, assets, services, and other items of value to its related foundation without jeopardizing its tax-exempt status or that of the foundation (although the more frequently this occurs, the greater the risk that the separate corporate existence of the foundation will be disregarded). This is because, in most cases, the activities of the related foundation are also in furtherance of the tax-exempt purposes of the association (e.g., educational programming, publishing, research, grants, etc. which are directed at and benefit the members of the trade or profession represented by the association), so the contributions to the foundation advance the association's tax-exempt purposes.

Consequently, while associations must carefully track and record the nature and amount of all cash, assets and services they provide to their related foundations, it is not necessary for the related foundation to reimburse the association for the full fair market value of such items, or to reimburse the association at all. It is permissible to do so -- as long as the reimbursements do not exceed fair market value -- but not required. The related foundation should record all such non-reimbursed items as in-kind contributions.

Foundation Contributions to the Parent Association

In contrast to the great latitude permitted regarding association contributions to their related foundations, the opposite is true with regard to foundation contributions to their parent associations. Here, as the conditions of tax exemption of 501(c)(3) organizations are much more stringent and limited than those of 501(c)(6) organizations, items of value can only flow from related foundations to parent associations if done in conformance with strict guidelines.

A related foundation clearly may transfer items of value to its parent association in exchange for consideration at fair market value. For example, if a foundation sells books it publishes to its parent association at the same price it charges others to purchase the books, there is no problem. If a foundation owns its headquarters building and leases space in the building to its parent association at fair market rent, there is no problem.

A problem arises, however, when the foundation seeks to transfer items of value to its parent association without receiving anything in return, or receiving consideration at less than fair market value. In addition, IRS officials have indicated informally that the newly-enacted "intermediate sanctions" law may be applied to transfers of items of value from related foundations to their parent associations when less than fair market consideration is received in return (with the resulting penalty taxes levied on the associations).

A related foundation may properly make grants, make contributions in the form of educational seminars, publications, etc., and otherwise transfer its assets to its parent association without adequate consideration only if it can be clearly demonstrated that such transfers are strictly for one or more qualifying educational, charitable or scientific purposes. In other words, use of the transferred items must be restricted for specific educational, charitable or scientific purposes, and the foundation must retain ultimate control and discretion over use of the items. Strict accounting procedures should be maintained to ensure that the items are not used by the association to defray its general operating costs.

It is thus permissible for a related foundation to carry out its educational purposes in conjunction with the activities of its parent association. For example, the foundation and association may jointly sponsor educational programs, or the foundation may sponsor educational programs in conjunction with professional activities of the association (such as educational seminars at the association's annual meeting). The foundation bears the burden, however, of being able to prove that its funds and resources were used solely for the educational programs, and not to carry out professional or business activities of the association. Furthermore, it is critical that the educational programs be promoted and open to all members of the relevant trade or profession (not merely those who are members of the association), and that the foundation's name be clearly and conspicuously used in conjunction with the promotion and staging of the educational programs (not merely the name of the association). Furthermore, if the foundation's nonprofit postal permit is being used to mail promotional materials for the educational programs, it must ensure that the postal permit is not at all being used to promote the professional or business activities of the association (but only the educational programs of the foundation).

The joint sponsorship of educational programs and publications by foundations and their parent associations can be accomplished either by having the foundation pay its share of the costs directly (such as room rental, publishing costs, and speaker fees), or by having the association pay the costs up front and seeking reimbursement of a specific dollar amount from the foundation, so long as a strict accounting is maintained at all times of the educational use of the foundation's funds.

Finally, when educational programs or materials are offered by a related foundation and are promoted to, among others, members of the parent association, the foundation often will seek to offer discounts to the association's members on such programs and materials. As a general rule, a discount to association members on programs and materials offered by the foundation would be seen as a transfer of assets from the foundation to the association without consideration and would be prohibited. However, most organizations avoid this result by having the association provide something of comparable value to the foundation in return for the foundation offering discounts to association members. For example, many associations permit their related foundations to utilize their membership mailing list to promote educational programs and materials in return for the foundation providing discounts on such educational programs and materials to association members. Where this is not a practical approach, the association may consider donating other goods or services -- such as the use of trademarks and logos, staff services1, or even cash -- to the foundation in return for member discounts. However, it is important that the fair market value of the goods, services or other consideration provided by the association approximate the value of the member discounts offered by the related foundation. Regardless of the approach used, the association must always provide something of comparable value to the foundation in exchange for member discounts.


Whether the benefits to an association of establishing a related foundation will outweigh the burdens will differ in each case. As a general rule, if an association is not prepared to do the detailed recordkeeping, cost allocation, and other administrative functions necessary to maintain the requisite financial, management and operational separation, then it should not establish a related foundation. It is no doubt burdensome to always hold separate board meetings, maintain separate financial records and time sheets, allocate joint program expenses and overhead, and utilize separate letterhead stationery, among other requirements. At the same time, there are significant benefits and opportunities to be derived from the creative use of related foundations. Ultimately, the question to be asked is whether the tax, legal and other benefits of establishing the foundation will serve such a useful purpose for the association that the cost and trouble will be worthwhile. More often than not, the answer will likely be "yes."

Note: If the association chooses to perform administrative services for the foundation in exchange for member discounts, the IRS could maintain that the value of the member discounts received by the association for its administrative services represents unrelated business income. In general, fees received by an association for performing administrative services for another tax-exempt organization are taxable, even if the other organization shares a related purpose or mission.

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