 |
 |
 |
 |
 |
 |
 |
Archives
November 2003
Court Denies 501(c)(3) Bid of Organization on the Basis of Commerciality
Many public relations firms, media consultants, and other entities that are organized to provide services to nonprofit organizations hope to qualify as nonprofit, tax-exempt organizations themselves. While 501(c)(3) status is possible if the organizations are properly structured, a recent federal court ruling denying tax-exempt status to the Airlie Foundation serves as a reminder that such organizations should closely evaluate the nature and extent of their commercial activities or risk jeopardizing their tax-exempt statuses.The Airlie Foundation was established to conduct seminars, meetings and other events aimed at encouraging understanding of the physical and social sciences, and similar educational endeavors. In the 1980's its 501(c)(3) status was revoked because it provided private benefit to its founder and operated for a commercial purpose. It then sought to regain its (c)(3) status.
Airlie operates a conference center, the vast majority of whose income is rental income derived from government groups, charitable organizations and businesses. The central question addressed in the court's opinion was whether the manner in which the conference center is operated indicated Airlie had a substantial commercial purpose.
Operational Test
In order to qualify for 501(c)(3) status, an organization must both be organized and be operated for charitable purposes. If more than an "insubstantial part" of an organization's activities are for "non-exempt" purposes, then the organization does not qualify for tax exemption. That is to say, a tax-exempt organization may conduct insubstantial commercial activity (although it may be required to pay Unrelated Business Income Tax on revenue from such activities). However, excessive commercial activities jeopardize an organization's tax exemption. One justification for this rule is that tax-exempt organizations hold an unfair advantage if allowed to compete for clients or customers with commercial entities.
Measuring Commerciality
The IRS and the courts look at all relevant facts and circumstances to determine whether an organization operates for commercial or exempt purposes. In Airlie, the court identified a number of factors: Whether the organization's activities compete with for-profit commercial entities; whether the organization provides services predominately below cost or whether it makes a profit; whether the organization maintains a reasonable, rather than excessive, financial reserve; whether the organization advertises its services; and the extent to which the organization receives charitable donations.
Airlie argued that the conference center's pricing and business policies were intentionally designed to support charitable purposes. In some respects, the figures appear to support Airlie's position: Approximately 70 percent of the groups using the Foundation's facilities were government or nonprofit groups. The organization's average profits on conferences were essentially negligible and it fully or partially subsidized nearly 20% of the conferences it hosted. Airlie also operated on a nearly break-even basis and its standard conference hosting fees were set approximately 20% below competitive commercial rates.
However, as the court's opinion makes clear, the test of whether an organization has a substantial commercial purpose is not simply mathematical. The important factors the court identified in ruling against Airlie were that it derives "substantial income" from weddings and special events and competes with for-profit conference facilities that also host conferences and special events. In addition, the court found that Airlie expends substantial funds on promotion of its conference facilities, including through a website.
Possible Lessons
Although the Airlie decision falls short of providing a roadmap for exempt organizations to avoid excessive commercial activity, it does provide useful insight into the factors the IRS and the courts deem significant. First, it is clear that organizations which do not benefit the public directly and have a predominant activity which earns fees for services are at risk of excess commerciality. Second, the tax exemption of a service-providing organization will be safer if the organization offers its services at a price below its cost to nonprofits and makes up the difference through donations and grants, rather than attempting to operate a self-supporting service program. Third, a tax-exempt organization that provides services in exchange for fees should avoid extensive advertising.
The restrictions on commercial activities by tax-exempt organizations make it difficult to support an organization primarily through fee-for-service activities. Organizations that find themselves in this dilemma may want to consider spinning off their commercial activities in for-profit, taxable subsidiaries to avoid jeopardizing their own tax exemptions. That is a subject for a later article, however.
By Paul Tanis
FEC Tightens Rules on the Use of Campaign Finance Disclosure Reports A recent advisory opinion issued by the Federal Election Commission ("FEC") has denied a charitable organization's request to use donor identification information gathered from campaign finance disclosure reports for education and advocacy.
The Federal Election Campaign Act ("the Act") requires federal political committees to file regular reports with the FEC containing the full names and addresses of donors whose contributions exceed $200. In order to protect donors' privacy, the Act prohibits anyone from selling or using information contained in the reports "for the purpose of soliciting contributions or for commercial purposes." This is commonly known as the "sales-or-use restriction." The 501(c)(3) organization requesting the opinion, the National Center for Tobacco-Free Kids ("NCTFK"), had asked if it could send educational or lobbying communications to persons named in candidate and political committee reports filed with the FEC. The FEC responded that the activity would violate the sales-or-use restriction.
Prior to the issuance of the opinion, there had been speculation that the sales-or-use restriction applied only to activities such as fundraising, marketing products, and selling FEC reports. Based solely on a reading of the Act's language, it seemed plausible that a charitable or other tax-exempt organization could use donor identification information it collected from FEC reports to mail educational or advocacy materials so long as the communications did not include solicitations or involve other commercial activity.
Rather than basing its opinion on the explicit language of the Act, however, the FEC looked to the Act's legislative history to interpret Congress' intent behind the sales-or-use restriction. When the Act was before Congress, some members had expressed concern that it left political benefactors vulnerable to "all kinds of harassment." Accordingly, the FEC found the restriction was added to "protect the privacy of the...citizens who may make a contribution to a political campaign or...party." The FEC concluded that NCTFK's proposed communications "present[ed] the possibility of repetitive and intrusive communications to contributors," which was the kind of harassment Congress wanted to prevent. Because the communications were "antithetical" to the purpose behind the restriction's creation, the FEC decided they could not be allowed. Almost as an afterthought, the FEC also acknowledged that a committee has a legitimate ownership interest in its mailing list, and a broad interpretation of the restriction presumably helps protect that interest.
As a matter of law, the advisory opinion simply expresses the FEC's current interpretation of how far the sales-or-use restriction reaches. Nevertheless, it is likely this interpretation would be employed in any possible enforcement of the restriction by the Commission. Organizations that are in the habit of using information from FEC reports will likely want to stop, especially given the fact that reports are often seeded with fictitious names as a means of determining whether they are being used for improper purposes.
The advisory opinion is AO 2003-24, and it can be viewed at: http://herndon3.sdrdc.com/ao/ao/030024.html .
By Josh Sadlier
IRS Issues New Plain-language Guides for 501(c)(3)'s
The IRS has recently issued two new plain-language guides on applying for, and maintaining,
501(c)(3) status.
Publication 4220 is entitled "Applying for 501(c)(3) Tax-Exempt Status," with detailed
answers to the following questions:
• why apply for 501(c)(3) status;
• who is eligible for 501(c)(3) status;
• what responsibilities accompany 501(c)(3) status; and
• how do you apply for 501(c)(3) status?
It can be downloaded in PDF format by clicking
here.
Publication 4221, "Compliance Guide for 501(c)(3) Tax-Exempt Organizations,"
gives answers to questions about good operating standards for 501(c)(3) organizations, such as:
• why keep records;
• what records should be kept;
• how long should you keep records;
• what federal tax reports and returns must be filed; and
• what disclosures must a 501(c)(3) organization make?
The Compliance Guide can be downloaded by clicking
here.
By Eric Tars
This publication is designed to provide accurate and authoritative information about the subject matter covered. It is not distributed with the intent to render legal, accounting, or other professional advice. The services of a competent professional should be sought if legal advice or other expert assistance is required.
Newsletter Home | HarmonCurran Home
