Working Better Together
CAPLAW’s Guide to Mergers and Shared Services
Overview of Shared Services Arrangements for CAAs
How might sharing services benefit our CAA?
Sharing services may benefit a CAA by helping it achieve one or more of these goals:
- Reduce administrative costs – for example, by more efficiently or economically performing administrative functions such as payroll, purchasing or management of employee benefits.
- Enhance organizational capacity – for example, by gaining access to expertise and systems the CAA does not have itself.
- Increase flexibility – for example, by paying for only those administrative services needed and only when they are needed.
- Focus on mission – for example, by permitting CAA leaders to devote more of their time to programmatic functions and other activities related to their core poverty fighting mission.
Because CAAs seeking to share administrative services are often already staffed so leanly, the primary benefit they see from sharing administrative services will most likely be increased access to expertise and talent that they could not afford or could not locate on their own, rather than cost savings.
If you are curious about whether a merger or shared services arrangement would be more beneficial for your CAA, take a look at the Benefits and Drawbacks section of CAPLAW’s Sample Shared Services Agreement.
What are some examples of ways CAAs have shared services?
CAAs have participated in numerous types of shared services arrangements, such as the following:
- CAA A manages and staffs CAA B’s entire organization.
- CAA A manages the administrative and fiscal functions of CAA B as well as CAA B’s programs (but CAA B continues to employ program staff).
- CAA A engages another nonprofit to provide it with an executive director and chief financial officer.
- CAA A provides a fiscal director to CAA B.
- CAA A provides fiscal and HR services to CAA B.
- CAA A provides a weatherization director to CAA B.
- CAA A provides an entire weatherization department, including the weatherization director, crews and inspectors, to CAA B.
Is there a standard agreement for CAA shared services?
Unfortunately, no, but CAPLAW has put together a Sample Shared Services Agreement that CAAs can adapt to their particular arrangement. One advantage of shared services arrangements is that they can be structured in a variety of different ways in order to best meet the needs of the organizations involved. For this reason, however, there is no standard form of shared services agreement that can be used across the board in all CAA shared services arrangements. The Sample Shared Services Agreement CAPLAW has published serves as a guide to the provisions that are likely to be included in a shared services agreement. It includes bracketed text and footnotes corresponding to specific provisions, both of which are intended to help CAAs better understand what they may want to include and how to modify it. Since shared services agreements are governed by state contract law, CAAs should work with an attorney in their state to draft and negotiate the agreement. CAPLAW is available for consultations on the federal grant law aspects of such agreements.
Below are two sample agreements that other CAAs have used to structure shared services arrangements. Please note that these agreements were neither prepared nor reviewed by CAPLAW prior to their execution and may not cover all of the issues required in such arrangements. CAPLAW does not endorse the use of these sample agreements and is providing them for reference purposes only. Names and other identifying information have been redacted to preserve agency confidentiality. Please contact CAPLAW if you have any questions about the sample agreements.
What tax issues do CAAs need to consider when sharing employees?
CAAs that enter into shared employee arrangements must consider a number of tax issues. The issues most commonly seen relate to a nonprofit organization’s tax-exempt status, as well as the withholding and payment of payroll and employment taxes for shared employees.
For a detailed discussion of these and other tax considerations, please see CAPLAW’s article, Tax Issues to Consider When Sharing Employees.
What unrelated business income tax (UBIT) issues should we think about before entering into shared services arrangements?
A CAA thinking about providing administrative services to another CAA or nonprofit organization as part of a shared services arrangement must consider whether any income it generates will subject to federal unrelated business income tax (UBIT). While 501(c)(3) nonprofit organizations are generally exempt from federal income tax, they may be liable for UBIT on the income generated from certain activities that are not substantially related to their exempt purposes. The purpose of the tax is to prevent tax-exempt organizations that operate commercial activities from gaining an unfair competitive advantage over for-profit entities doing similar activities. Activities are considered “unrelated” and income from such activities are subject to UBIT if they fulfill three criteria: (1) constitute a trade or a business (i.e., an activity intended to generate income from selling goods or providing services), (2) are regularly carried on, and (3) are not substantially related to the furtherance of the organization’s tax-exempt purposes. Certain unrelated activities may also be subject to UBIT at the state level, so CAAs considering shared services arrangements should check state-specific UBIT requirements.
Generally speaking, fees received from providing administrative services to another organization, including another nonprofit, tax-exempt organization, count as unrelated business income.1 The IRS does not consider the provision of services to another exempt organization to be an exempt function, even when the two exempt organizations share similar missions or have the same category of exempt status. For example, the IRS ruled that a 501(c)(6) tax-exempt business association’s provision of management services for a fee to a 501(c)(3) tax-exempt organization that it had founded to promote economic development was not related to the 501(c)(6) organization’s exempt purposes.2 The IRS found that the services provided, which included handling correspondence, maintaining books and records, answering phones, and managing the 501(c)(3) organization’s license, were of the kind ordinarily carried on by for-profit entities. Thus, the fees collected to provide the services were deemed to be unrelated business income to the 501(c)(6) organization and subject to UBIT.
There are two notable exceptions to this general rule:
- Providing services to a legally related, exempt organization: The IRS has said that tax-exempt organizations may provide administrative services on a fee-for-service basis to other exempt organizations that are legally related or under common control (e.g., one entity is the parent of the other entity; or the entities are subsidiaries of a common parent entity). However, an exempt organization is not related to another exempt organization merely because they both engage in the same type of exempt activities.3 Because nonprofit organizations are typically nonstock corporations and thus do not have owners, an actual parent-subsidiary relationship may not exist. However, the IRS will infer a parent-subsidiary relationship where there is a “close control relationship” between the organizations.4 Evidence of this type of relationship may arise when one entity has the authority to select another entity’s directors and officers, or where one entity has “control and close supervision” over another entity’s affairs.5 The IRS has found such a relationship to exist between an exempt, 501(c)(10) domestic fraternal society and its member organizations, where the fraternal society appoints its member organizations’ board members;6 as well as between a 501(c)(4) social welfare organization and its related 501(c)(3) foundation, where the social welfare organization appoints the majority of the directors of the foundation.7 If the entities are related, the services provided will not be treated as an unrelated trade or business and will not be subject to UBIT.
- Charging a fee that is substantially below the CAA’s cost of providing the services: If the amount the CAA receives for providing the administrative services is substantially below the CAA’s cost of providing the service, the CAA will likely be able to argue that the provision of management services is itself a charitable activity and thus related to the organization’s exempt purpose.8 While the IRS does not define “substantially below cost,” it has indicated that providing services at 85%-90% of the provider’s costs (with the remaining costs subsidized by other grants or charitable contributions) may be sufficient.9 The IRS has found that charging a fee for services that is below market rate, but above cost, is not a charitable activity.10 Further, simply collecting a fee as reimbursement for the cost of providing the service is insufficient to establish the activity as charitable.11
Two other factors may impact the IRS’s treatment of the provision of administrative services as a related or unrelated activity:
- The nature of the services provided by the CAA: The IRS will look at how commercial the services appear to be and whether they compete with the services provided by other for-profit entities. The fact that the services compete with commercial enterprises will be considered strong evidence of the predominance of a nonexempt, commercial purpose.12 However, if the nonprofit organization can differentiate its services from those offered by for-profit entities and show that they are not competitive, the IRS may be willing to consider such services as related.13 For example, the IRS was willing to distinguish grant-making services to other charities from general management, accounting, bookkeeping, and legal services necessary for the daily operation of the charities—the IRS found that while the grant-making services were related, the other administrative services were no different from those offered by for-profit entities and thus were unrelated.14 The fact that commercial entities may also provide similar services is not, in and of itself, determinative; however, if there are commercial alternatives available, the CAA will have a hard time making the argument that it is uniquely qualified to provide a particular service to help other nonprofit organizations address unmet charitable needs.15
- The identity of the recipient of the services: Another factor the IRS will consider is the type of organization engaging the CAA’s services – is it another nonprofit organization or a for-profit entity? The IRS generally will treat services provided to non-exempt entities as unrelated business activities.
Thus, for a CAA that provides administrative services to a legally unrelated, tax-exempt entity (e.g., a nonprofit CAA that serves a neighboring service area), the IRS will look primarily at the fee that the CAA charges and the nature of the services it provides. General administrative, back-office services (such as HR administration, payroll processing, nonprofit accounting, IT servicing and support, etc.) will likely be deemed unrelated activities. The CAA can try to argue that it is uniquely qualified to provide a particular service and that the service helps address an unmet charitable need within the community it serves. However, if there are similar services offered by other for-profit entities, it may be hard to make the argument that the CAA is meeting an unmet need. If the CAA provides the services for a fee that is substantially below cost, the IRS will likely treat the activity as part of the CAA’s charitable mission. If the CAA provides the services at cost or for a fee that is above cost (e.g., cost plus a fixed amount or percentage), even if the fee is based on ability to pay or is less than what a for-profit entity would charge, the IRS is likely to find that the provision of the services is an unrelated business activity.
Tax-exempt organizations with gross unrelated business income of $1,000 or more annually must file a Form 990-T and attach any required supporting schedules and forms. This income is taxed at the regular corporate rate, but organizations can claim all applicable tax credits and deductions, including the general business credits. Thus, unless a CAA can meet one of the exceptions above or make the argument that its services are not competitive with those offered by commercial entities, a CAA will likely need to report the amounts it receives for providing the services as unrelated business taxable income on Form 990-T (if it generates $1,000 or more in such income in a year). If the CAA provides the services at cost, it will be entitled to deduct its ordinary business expenses on Form 990-T and may not ultimately owe any taxes; however, because Form 990-T requires reporting all gross income, the CAA is still required to file Form 990-T.
Note that while the IRS permits tax-exempt organizations to engage in a limited amount of unrelated activity (and pay taxes on the income generated from such activities), too much unrelated activity can jeopardize an organization’s tax-exempt status. How much activity is too much? While certain accountants try to provide a rule of thumb by saying that unrelated business income should not exceed a certain percentage of the organization’s budget (e.g., 10% or 25%), the IRS has never implemented a bright-line rule. Instead, the IRS uses a “commensurate in scope” test and asks how much time and resources the nonprofit organization is spending on its non-exempt activities in relation to what it is spending on its exempt activities.16 CAAs that continue to run their own direct services programs while providing some administrative support to other CAAs or nonprofit organizations will probably be able to argue that they are still primarily engaging in exempt purpose activities. However, because there is no bright-line test, CAAs seeking to conduct a substantial amount of unrelated activity may want to consider moving the activities into a separate, for-profit subsidiary to protect their tax-exempt status.
A CAA should consult with an attorney and/or an accountant familiar with federal and state UBIT requirements prior to entering into shared services arrangements to ensure that it is in compliance with all applicable laws.
1 Rev. Rul. 72-369, 1972-2 C.B. 245 (holding that a 501(c)(3) organization that regularly provides managerial and consulting services to another 501(c)(3) organization for a fee equal to cost is carrying on an unrelated business, as providing the services at cost does not contain the donative element necessary to constitute a charitable activity.)
2 IRS Tech. Adv. Mem. 9811001.
3 26 C.F.R. § 1.502-1(b).
4 PLR 9617031.
5 PLR 9617031; IRS Rev. Rul. 68-26.
6 PLR 9617031.
7 PLR 200022056.
8 IRS Rev. Rul. 71-529.
9 IRS Rev. Rul. 71-529; PLR 9347036.
10 BSW Group, Inc. v. Comm’r., 70 T.C. 352 (1978).
11 At Cost Services v. Comm’r., 80 TCM 573 (2000); IRS Rev. Rul. 72-369.
12 B.S.W. Group, Inc. v. Comm’r, 70 T.C. 352 (1978) (holding that a nonprofit organization’s provision of consulting services to other charities in policy and program development were similar to those offered by commercial businesses such as banks, personnel agencies, and trash disposal firms, and that competition with commercial firms is evidence of a nonexempt commercial purpose); Rev. Rul. 72-369 (providing managerial and consulting services to charities to improve their administration for a fee intended to recover costs is a commercial activity).
13PLR 200832027 (finding that a nonprofit organization that provided grant-making services to other nonprofit organizations at cost was engaging in a related activity, as the grant-making services drew upon the provider’s expertise and experience, and could be distinguished from other services that were commercial in nature, such as management consulting, accounting, bookkeeping, and legal services).
14 PLR 200832027.
15 PLR 200832027.
16 IRS Rev. Rul. 64-182, 1964-1 C.B. 186.
Do procurement rules for federal grant funds apply to shared services arrangements?
Yes. If a CAA provides administrative services to another CAA or federally-funded entity, the entity receiving the services must follow its procurement policy and ensure that it is in compliance with the procurement standards of the Uniform Guidance, 2 C.F.R. §§ 200.318-200.326. Depending on the aggregate dollar amount of the shared services agreement, the receiving entity receiving the services should use the appropriate method of procurement listed in the Uniform Guidance, 2 C.F.R. § 200.320. Services that fall under the micro-purchase threshold specified in the Federal Acquisition Regulation ($10,000, as adjusted periodically) do not require the entity to solicit competitive quotations, while services that exceed the micro-purchase threshold but not the “Simplified Acquisition Threshold” ($250,000) require that the entity obtain price or rate quotes from an adequate number of qualified sources.1
All procurement transactions must be conducted in a manner involving full and open competition. The revised procurement rules in the Uniform Guidance limit the circumstances under which entities can use sole source procurement (i.e., procuring services without competition). Sole source procurement is permitted only if one of the following situations applies: (1) the item is only available from a single source; (2) public exigency or emergency for the required procurement exists and will not permit a delay for competitive solicitation; (3) the non-federal entity requested in writing and obtained express authorization from the federal awarding agency or pass-through entity to use sole source procurement procedures; or (4) after solicitation of a number of sources, the non-federal entity determined that competition was inadequate.2 In light of the stricter requirements for sole source procurement, a CAA should take care to document its reasons for using a sole source procurement and, depending on the circumstances, may need to seek prior approval from its federal and state funding sources for the shared services arrangement.
A CAA is required to maintain, as part of its procurement policy, written standards of conduct covering conflicts of interest and governing the actions of their employees engaged in the award, selection, or administration of a procurement contract. A conflict of interest exists when such an employee, officer or agent, or any of his/her related parties (e.g., any member of his or her immediate family, his or her partner, or an organization which employs or is about to employ any of such related parties), has a financial or other interest in a firm considered for the contract. The CAA must ensure that its standards of conduct covering conflicts of interest:
- Provide for disciplinary actions for violations;
- Bar employees, officers, and agents from participating in the selection, award, or administration of a contract if they have an actual or apparent conflict of interest; and
- Prohibit officers, employees, and agents from soliciting or accepting gratuities, favors, or anything of monetary value from contractors or parties to subcontracts (except for situations where the financial interest is not substantial or the gift is an unsolicited item of nominal value).3
Under the procurement rules, CAAs are also required to maintain written standards of conduct covering organizational conflicts of interest.4 The Uniform Guidance defines “organizational conflicts of interests” as situations where, because of relationships with a parent company, affiliate, or subsidiary organization, the entity procuring goods or services is unable or appears to be unable to be impartial in conducting a procurement action involving a related organization.5 Thus, if the parties to the shared services agreement are legally related—for example, if one entity is the parent or sole member of the other, or if the two organizations are subsidiaries of a common parent entity—the entity procuring the shared services must follow its procurement policy with respect to dealing with the organizational conflict of interest.
1 2 C.F.R. § 200.320(a), (b).
2 2 C.F.R. § 200.320(f).
3 2 C.F.R. § 200.318(c)(1).
4 2 C.F.R. § 200.318(c)(2).
5 2 C.F.R. § 200.318(c)(2).
This resource is part of the National T/TA Strategy for Promoting Exemplary Practices and Risk Mitigation for the Community Services Block Grant (CSBG) program and is presented free of charge to CSBG grantees. It was created by Community Action Program Legal Services, Inc. (CAPLAW) in the performance of the U.S. Department of Health and Human Services, Administration for Children and Families, Office of Community Services Cooperative Agreement – Grant Award Number 90ET0433. Any opinion, findings, and conclusions, or recommendations expressed In this material are those of the author(s) and do not necessarily reflect the views of the U.S. Department of Health and Human Services, Administration for Children and Families.