Cost-sharing Agreements Between Affiliates 

Key Requirements for Nonprofit Cost-Sharing Agreements 

• Written Agreement: A formal document such as a memorandum of understanding, shared service agreement, or cost-sharing agreement is necessary to define the roles, obligations, and financial arrangements of each party. Written proof of cost-sharing methodologies is critical for passing AICPA/IRS standards and complying with federal or private grant reporting requirements. 

 

• Reasonable Allocation Methodology: Costs must be allocated based on a reasonable, documented methodology that reflects the actual benefits received such as percentage of staff time, square footage of space used, or direct usage. 

 

• Full Cost Coverage: Each organization, especially a 501(c)(4) sharing with a 501(c)(3), must pay at least its full, proportional share of costs, including salary, benefits, and overhead, to avoid violating tax-exempt rules. 

• Documentation and Verifiability: All shared costs must be verifiable from the organization’s financial records, ensuring they are not included as contributions under another award or agreement. 

 

• Timely Reimbursement: Payments should be made regularly and within a reasonable timeframe typically within 30 to 60 days to avoid the appearance of one nonprofit lending money to another. 

 

• Independent Boards and Controls: The nonprofits should maintain independent management and boards to ensure the agreement is managed properly and to address conflicts of interest. 

 

• Guiding Staff and Leadership: Clear allocation formulas and transparent billing ensure that accountability is maintained, even when there is staff or board turnover. 

 

• Arm’s Length Negotiation: The terms should be negotiated as if the parties were unrelated, ensuring fairness and avoiding private inurement or impermissible private benefit. 

 

Elements to Include in the Agreement  

• List of Entities and Type: Identify each entity’s full legal name, address, and which IRS type of nonprofit such as 501(c)(3) versus 501(c)(4). It is also helpful to identify any acronyms used for each entity. 

 

• Purpose and Scope: Description of the shared activities such as personnel, office space, equipment, or accounting services. 

 

• Cost Allocation Formula: Clearly define the method for calculating each party’s share of costs. Identify which items would be directly charged such as postage and delivery and which items are indirect costs. It may be necessary to also identify which costs are coded to programs, administration, or fundraising. 

 

• Timekeeping: Identify whether time sheets will be used for tracking time for each entity and include whether a shared overhead code will be allocated between the entities. 

 

• Payment Terms: Describe the schedule for invoicing and when reimbursements are due. Consistent timing for invoicing and reimbursing on a monthly or quarterly basis helps prevent unusually large due to/due from balances between the entities. 

 

• Term and Termination: The duration of the agreement and “escape clauses” for terminating the arrangement if it proves unfavorable or improper. The agreement should be reviewed annually to determine whether any changes are necessary based on operations and funding for each entity. 

 

• Liability and Insurance: Clauses for indemnification, ensuring each party has its own liability insurance and names the other as an additional insured, if appropriate. 

 

• Word Choice: For space-sharing, the agreement should avoid commercial terms like “rent” or “tenant” if the entity is exempt from property taxes. Instead, use words such as “occupancy agreement” to maintain noncommercial status. 

 

• Intellectual Property: Identify ownership of any intellectual property or materials created in connection with the agreement whereby costs were shared to collaborate on a project. 

 

• Prohibited Shared Costs: For certain costs such as lobbying or political spending, clearly identify that these items are not part of the shared costs. 

 

Final Thoughts 

Written cost-sharing agreements are essential for nonprofits that share personnel, space, services, or operational resources with affiliated entities. Proper documentation, reasonable allocation methods, and strong internal controls help organizations maintain compliance, preserve tax-exempt status, and avoid the appearance of private benefit or improper subsidization.