I am interested in getting advice on how to structure and operate a
service-based nonprofit organization, the activities of which are
closely aligned with a product-and-performance-based for-profit
business.  We have set up both businesses with strict separation of
revenues, expenses, bank accounts, etc.  The IRS has reviewed our
initial 1023 application for exemption and we are in the phase of that
process where they have asked specific organizational and operational
questions and we desire to respond in a manner that most effectively
reduces the risk of tax exemption denial.  The details of the
activities/business are as follows:
The nonprofit organization solicits contributions to support the
outreach activities of individuals that offer qualifying religious
musical and spoken programs to the public.  Performance fees and
travel expenses are charged to the presenter.  These fees go to the
nonprofit.  For presenters that cannot afford the costs, such charges
may be waived and will be born by the nonprofit.  Appropriate
nondiscrimination language is in our by-laws, and criteria for
consideration of fee/expense waiving are also described. At these
events, CDs and other products produced and manufactured by the
for-profit business are offered for sale.  The artists, whose outreach
ministries are supported by the nonprofit, receive royalties, etc.
from the CD sales.  The CDs and ancillary products are also
distributed commercially by the for-profit business.  The Board and
shareholders of the for-profit are totally separate from the Board of
the nonprofit.  None of the nonprofit board members are compensated,
however the officers of the nonprofit and the for-profit are the same.
 One of the officers is also a shareholder in the for-profit.  The
officers are also salaried by both entities; however, they cannot vote
on, approve or set their salaries in the nonprofit.  That rests solely
with the Board.  Additionally, one of the officers is an artist whose
CDs have been produced and sold, individually in the beginning, and
now through the for-profit.  He has been providing inspirational
testimony, exposition and music for several years.  It is because of
the success of his activities that the two organizations came to be. 
Numerous individuals desired to contribute to his ministry, and there
was no vehicle for this, ergo, the 501(c) 3.

My question is: Given the information above, are there any apparent or
hidden dangers that could hinder the 501(c) 3 approval, and are there
any IRS regulations that prohibit the close alignment of a for-profit
and a nonprofit that entities as described above?

Hello;

	In response to your question concerning 501(c) 3 compliance and IRS
regulations concerning a for-profit and a non-profit organization with
close ties I have found the following information:

	There are some concerns you may need to address.  In order to be
eligible for 503(c) 3 status an organization must be a “corporation,
community chest, fund, or foundation, organized and operated
exclusively for religious, charitable, scientific, testing for public
safety, literary, or educational purposes, or to foster national or
international amateur sports competition…or for the prevention of
cruelty to children or animals, no part of the net earnings of which
inures to the benefit of any private shareholder or individual, no
substantial part of the activities of which is carrying on propaganda,
or otherwise attempting, to influence legislation…, and which does not
participate in, or intervene in…,any political campaign on behalf of
(or in opposition to) any candidate for public office.”
	Now to put that information to practical use. 
The Code and Regulations of the IRS will scrutinize the eligibility of
an organization’s exempt status by administering two tests, an
organizational test and an operational test.
According to the International Center For Not-For-Profit Law, the
organizational test requires that an organization’s articles or
organization limit it to the pursuit of one or more “exempt purposes,”
 i.e., charitable, religious, scientific or educational purposes.  The
organization must expressly, or insubstantially, not be involved in
nonexempt activities.  For example an organization cannot claim exempt
status if its articles of organization empower it solely to be engaged
in retail, manufacturing, etc., regardless of whether it also states
it is raising funds for a charitable purpose.  Furthermore, the
organization must be organized so that upon dissolution, its assets
will be distributed for exempt purposes to exempt organizations of
certain types.
	The operational test requires that a section 501 (c) 3 organization
engage primarily in activities that accomplish one or more exempt
purposes.  Only an insubstantial part of its activities can be for
nonexempt purposes.  The operational test will look at an
organization’s purposes and activities.
	As the organization must be operated primarily, but not solely, for
exempt purposes, the Code and Regulations will look at such factors as
“profit motive, absence or presence of substantial profits, extent of
competition with commercial organizations, reliance upon volunteers,
amount of payment to salaried employees, and similar considerations.”
	The foregoing is a summary of what you may expect the Codes and
Registration to look at, however, the most obvious concern may be the
issue of private inurement.  The code requires that an exempt
organization must be operated so that no part of net earnings inure or
advance the benefit of any private shareholder or individual, “an
organization that channels the benefits of its financial resources
directly or indirectly to those who control it will not be considered
non-profit for purposes of federal law and will not qualify.”
	In reviewing the criteria for 503(c) 3 exempt status and considering
your organization does have a shareholder involved in both
organizations and receiving a salary from the non-profit it could be a
real concern.  Again citing the International Center For
Not-For-Profit Law, “in order for impermissible private inurement to
be found to exist, generally the private individual in question must
be found to be an insider in the organization (frequently a corporate
director, trustee or officer), and must generally be in a position to
control or influence the organization's actions in connection with the
benefit to be conferred. Unlike the requirement of a substantial
exempt purpose (where insubstantial and incidental non-exempt purposes
may be found to exist without preventing the organization from
qualifying for section 501(c)(3) status), even the smallest amount of
private inurement can potentially defeat an organization's claim to be
a section 501(c)(3) organization.”
	You may want to consider consulting with a CPA or a professional
experienced in this area to ensure your organization is in compliance
with the current codes and regulations.

Following is a list of websites you may find helpful:

International Center for Not-For-Profit Law
http://www.icnl.org/gendocs/taxlaws.html


Internal Revenue Service
http://www.irs.gov/charities/article/0,,id=96099,00.html

The NonProfit Times
The Leading Business Publication for Nonprofit Management
http://www.nptimes.com

Good luck!!!

The biggest risk that you face is what is called "private inurement"
in which the assets of the charitable entity is used to enhance the
position of the for-profit entity.  An example is if a manufacturer's
private foundation (that received charitable donations from the
manufacturer) provides loans to low-income individual to assist their
purchase of the manufacturer's product; while a valid charitable
purpose, the methodology used betters the competitive position of the
manufacturer.

IR Reg 1.501(c)(3)-1(e) specifically allows a charitable organization
to carry on a trade or business in furtherance of its charitable
purpose as long as the trade or business is in furtherance of its
charitable purpose.

It would seem to me that your position might be strengthened if the
non-profit paid the expenses of the performer and used the forum to
promote its charitable purposes.  With the performer paying the
non-profit, it appears that the performer may be paying a marketing
fee to receive the imprimature of the non-profit, particularly if the
for-profit holds the marketing rights to the performer.

It has been several years since I practiced in this area, but a good
place to find additional information regarding your question is a book
by Bruce Hopkins called The Law of Tax Exempt Organizations.