Expansion: Should Your Nonprofit Add Chapters or Affiliates?
Many of the nonprofit organizations you know in your community are actually a chapter or affiliate organization of a larger nonprofit (e.g. Habitat for Humanity or Boys and Girls Clubs of America). Having chapters or affiliates amplifies the impact of the work an organization undertakes in order to fulfill its mission. A larger organization overseeing the chapters and affiliates can be referred to by a variety of names, but for this blog post, I will refer to it as the “parent organization.” The parent organization will oftentimes expand its nationwide reach through a chapter or affiliate structure to meet a need in a new geographic area. The most effective way to do this is to connect with local leaders who are also passionate about the parent organization’s mission and purpose. The parent organization will then need to determine which structure is the best fit for accomplishing its organizational goals: a chapter structure or affiliate structure.
Chapter, Affiliate; Tomato, Tom-ah-to?
Not quite. While it is very common for the term “chapter” and “affiliate” to be used interchangeably in practice, they are not in fact the same. The figures below demonstrate the difference visually.
Generally speaking, chapters are more closely associated with the parent organization (all being part of the same nonprofit corporation), while affiliates are frequently more distanced (all being separate legal entities). Listed below is an overview of the three (3) primary distinctions between chapters and affiliates. While these are meant to aid your organization’s consideration of which structure to choose, this is not legal advice.
1. Control, Regulation, and Liability
If the parent organization seeks to maintain greater control, a chapter structure may be best. If the parent organization is hoping to allow a considerable amount of independence and general autonomy, however, an affiliate structure is more likely to fit your needs.
With a chapter structure, a single nonprofit corporation exists and operates in multiple jurisdictions. Everyone lives together and dies together in one corporate structure. There exists one governing Board of Directors, with each chapter is administered by chapter-level officials (akin to a committee that reports to the single Board of Directors). A chapter structure is good when the parent organization wants to retain maximum control over its various nationwide programs, own property centrally, and enforce standards of conduct. However, a chapter structure is challenging because the single nonprofit corporation will bear all liability. Naturally, a successful legal claim against one chapter’s program will expose all of the parent’s assets and other chapters to that single liability.
With an affiliate structure, multiple legal entities exist instead of only one – a parent organization as well as several separately formed entities as its affiliates. Affiliates can be structured as LLCs or nonprofit corporations. Because each affiliate is a separate legal entity, it will have its own governing Board of Directors, meeting minutes, Bylaws, policies, bank accounts, books and records, and tax/government compliance filings. Affiliates can own property separate and apart from the parent organization. Additionally, affiliates bear their own legal liability separate and apart from the parent and other affiliates. The parent’s authority over its affiliates would be as set forth in an affiliation agreement (sometimes called a Charter and License agreement) between each affiliate and the parent.
It can be a significant commitment, however, to take on either type of structure. Therefore, seeking legal advice prior to expansion is crucial.
2. Tax Implications
Depending on the classification of the parent organization, for example 501(c)(3) or 501(c)(6), an affiliate organization of a different classification may provide opportunities otherwise unavailable to the parent. This can be best explained through a few examples. Example 1: because 501(c)(3) organizations are limited in their ability to participate in political activities, it may be able to increase lobbying efforts through an affiliated 501(c)(4) organization. Example 2: because 501(c)(6) organizations cannot provide tax deductible charitable contributions to its donors, it may want to establish an affiliated 501(c)(3) organization to increase the incentive to donate. While the tax implications of these endeavors will vary depending on the classifications of the participating organizations, it is important to keep in mind that this option is only available through an affiliate structure as opposed to a chapter structure. See IRS Pub. 557 for more information). Furthermore, affiliates may assist the parent by separating unrelated business activity from the parent organization to protect the parent’s tax exempt status.
3. IRS Filing Requirements
A parent organization with a chapter structure relies upon a single IRS tax-exemption determination, or an “individual exemption.” Remember, there is only one corporate entity so that single entity. Because there is only one legal entity, the parent organization with a chapter structure must file a single annual tax return that includes all of its chapters. Simply stated, a parent organization with a chapter structure must consider the financial activity of its chapters as part of the parent organization’s financial activity and report it collectively on a single IRS Form 990 series return. This means the parent organization must collect each chapter’s financial activity and consolidate it for purposes of financial accounting.
In general, a parent organization with an affiliate structure can either apply for a “group exemption” or have each affiliate apply for its own individual exemption. In order to qualify for group exemption, the parent organization and its affiliates must have a specifically defined relationship that demonstrates the parent organization’s general supervision or control over its affiliates (see IRS Pub. 4573 for more information). When a group exemption is granted by the IRS, the parent organization can choose to have each affiliate file its own IRS Form 990 series return, or it can consolidate each entities’ financials on a single return. With a group exemption, the parent organization must annually submit an up-to-date list of affiliates (called “subordinates” by the IRS). In lieu of a group exemption, each affiliate can apply for its own individual exemption.
Bonus Consideration: Non-legal Reasons
While each of the above points are based on legal considerations, it is likely that your organization is thinking about several non-legal implications of choosing between a chapter or affiliate structure. Non-legal considerations could include donor preference, impact on programming, or even political considerations. Whatever the reason, all considerations should be weighed in conjunction with the above legal points to help you and your organization start planning your next steps toward expansion.