In the complex world of tax-exempt organizations, understanding the relationships between various legal entities is not just a matter of good housekeeping – it’s a necessity. Entity structure charts serve as the blueprint for understanding these relationships. Following are five reasons tax-exempt organizations should regularly review and update their entity structure charts.
- Complying with reporting requirements
IRC Section 6033 requires tax-exempt organizations to disclose certain information on various IRS forms, including Form 990, “Return of Organization Exempt From Income Tax,” and Form 990-T, “Exempt Organization Business Income Tax Return (and Proxy Tax Under Section 6033(e)).” Among other things, the forms require disclosure of related entities and transactions. Furthermore, intercompany transactions between an exempt organization and its subsidiaries often result in complex tax reporting, not to mention tax compliance for taxable entities. Developing and maintaining entity structure charts can help an organization accurately track and identify related entities and avoid reporting and underpayment penalties.
- Maintaining tax-exempt status
Maintaining tax-exempt status is a critical concern for all exempt organizations and crucial to this is understanding the operational dynamics within a multientity system. Entity structure charts can help identify transactions or relationships that might lead the organization to engage in unrelated activities that, if substantial, could potentially jeopardize the organization’s tax-exempt status. Thus, understanding the entity structure chart is essential for risk management and safeguarding the tax-exempt status of the organization.
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Reviewing the entity structure chart also can identify opportunities to add a taxable subsidiary to an organization to provide more flexibility to increase the scope of permissible activities.
- Managing unrelated business income tax (UBIT) implications
Tax-exempt entities should consider the UBIT implications of their activities. Activities that are not substantially related to the organization’s exempt purpose can generate UBIT, leading to liability for tax. Reviewing the entity structure chart helps the organization’s management understand potential UBIT implications. An entity structure chart can provide a snapshot of entities and where a particular activity with potential for UBIT might be housed. It also can highlight UBIT-generating activities stemming from joint ventures and certain controlled entities, which is important because receipts or accruals of interest, annuities, royalties, or rent from a controlled entity are subject to special tax treatment and might be considered UBIT. In short, proactive planning using an entity structure chart can help mitigate tax exposure.
- Making strategic decisions
Organizations create new entities or undergo restructuring, mergers, or affiliations to better align with their strategic goals. Regularly reviewing the entity structure chart can assist leadership in making informed decisions about the organization’s structure and its alignment with long-term objectives. Reviewing the entity structure chart also can help identify potential inefficiencies or redundancies – for example, forming a new entity when an existing shell corporation could be repurposed instead.
- Having transparency and accountability
Transparency and accountability are cornerstones of good governance for tax-exempt organizations. Stakeholders, including donors, members, and regulatory bodies, expect clear information about how an organization is structured and operates. Making a well-maintained entity structure chart available to these stakeholders provides transparency and promotes trust and confidence by offering a clear and accessible overview of the organization’s structure.
Looking ahead
Entity structure charts can be more than just diagrams. When used effectively, they can be strategic tools for compliance, risk management, and operational clarity. Tax-exempt organizations should keep their entity structure charts up to date and integrate review of the charts into regular organizational internal risk management procedures. Taking these steps can help organizations navigate the complex tax-exempt organization regulatory environment with confidence and maintain focus on advancing their mission.
