Non Profit Law
Galston – Fall 2011
Governing Law
 State Law – each state has different nonprofit/corporate law requirements
 Model Nonprofit Corporation Act (MNCA) – not adopted by any state
 Model Nonprofit Act of 1952 – Adopted by 12 states
 Revised Model Nonprofit Act of 1988 – 26 states loosely base laws on RMNA
 Internal Revenue Code
 Treasury Regulation (Official Interpretation of the IRC)
 Revenue Ruling – IRS admin. ruling that applies Code to particular facts (nonbinding)
 Gen.Counsel Memo – explains reasoning behind Rev. Rulings
What is the Non-Profit Sector?
 Difference between federal tax-exempt and state non-profit (state law term)
o Nonprofit—must file within state and assert a promise that the organization will exist
for a certain purpose and with a certain form
 Under state law, all you have to allege is any lawful activity and allege the nondistribution constraint
o Tax-Exempt—any entity that is tax exempt is a non-profit
 Not every entity that is a non-profit is tax exempt
 Tax exemption must come from the feds
 Lots to do to become federally tax exempt
o Benefits
 State: state income tax, sales tax, property tax, and qualifies for tort liability
statutes in that jurisdiction
 Federal Benefits: pension rules, federal income tax, FUTA taxes, postal rates
are lower, relief from tort liability
o Many states piggy back on feds in deciding on whether to give state exemption
 Some states require federal income tax exemption to qualify for state income tax
 Property Tax Exemption: many states look to local benefits to provide property
tax exemption
 Many use a formula (ie, 30% of services must be provided in state)
o Fed. Tax Exempt:
 501(c)(3)—Charity
 Public Charities—universities, hospitals, etc.
 Private Foundations—very heavily regulated; Gates Foundation
 Other 501(c)
 501(c)(4)—social welfare orgs; public purpose and look a lot like (c)(3)s
but engage in political activities including lobbying; beneficiaries are not
considered a charitable class
 501(c)(5)—unions and labor orgs
 501(c)(6)—trade ass’ns; chambers of commerce
 Other 500s 527—political organizations
 528—homeowners ass’n
 529—tuition program
 530—educational savings account
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What are the characteristics of a non-profit
o (1) Voluntary organizations (not-government)
o (2) Operate without distributing profits to stakeholders
 Non-distribution constraint---whatever revenues are leftover do not go to
stakeholders; no profit share, money is meant for the beneficiaries
o (3) They exist without simple and clear lines of ownership and accountability
How much is too much to spend on fundraising?
o IRS looks for relationship between source of money and the recipient
Dimensions of Non-Profit Sector
o 2.1 percent of GDP; 1.5 million 501(c); $1.4 trillion for public charities (501(c)(3)’s
 Charitable Assets (public charities)--$2.6 trillion; 7-9% of workforce
o Health takes more than half of tax-exempt entities
o Human Services: crime and legal related, food and employment, disaster preparedness,
recreation
o Public Societal Benefits: civil rights, social action and advocacy, volunteerism
o 73-75% of contributions are made by individuals
o The revenue from most non-profits come from fees (hospitals, tuition)
 67% comes from fees for services, not individuals donations
Purposes of the Non-Profit Sector: Justifying the Charities
o (1) Cost—
 Tax Expenditure:
 Amount government loses by deductions $54 billion
o (2) Public Services
 when the government or business does not provide for certain services
(immigration representation; religions)
o (3) Advocacy
o (4) Experimentation
o (5) Diversity of Services
o (6) Speedier Services
STATE LAW TREATMENT OF NONPROFITS
CHAPTER 2. STARTING THE ORGANIZATION AT THE STATE LEVEL
II.
Considerations of Form When Setting up a Nonprofit Organization
“Research, Money, Personal Support are Key to Successful Charity Startups”
 Many nonprofits fail early because of lack of these things
A.
For-Profit or Nonprofit – Newman’s Own and Google are “for-profit” charities
B.
Unincorporated Ass’n, Trust, Nonprofit Corporation
1.
Unincorporated Ass’n: group of two or more people working together for a
common purpose, who have not formalized the organization as a corporation or
a trust
2.
LLC and Low-Profit Limited Liability Company (L3C): specific type of
unincorporated ass’n that receives protection against the liability it would
otherwise face as an unincorporated ass’n; L3C is a for-profit w/ a nonprofit
soul—simpler to create than normal nonprofit
3.
Trust: trust instrument that irrevocably dedicates specific property to the benefit
of the community, rather than to the benefit of an individual
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4.
C.
D.
E.
III.
Nonprofit Corp.: entity that can sue and be sued, K, and hold property;
governed by board of directors
Public Benefit or Mutual Benefit
1.
Mutual Benefit: serves the interest of its members (clubs, unions)
2.
Public Benefit: Serves the interests of others (may become 501(c)(3))
Membership of Non-Membership Organization
1.
Non-Membership: governed by a board of directors
2.
Membership: members elect directors, approve bylaws, and vote
on major decisions (like shareholders); (advocacy groups, churches,
mutual benefit orgs.)
Variations Among State Nonprofit Corporations Statutes
1.
Focuses on NY, Cal, and Model Nonprofit Corporation Act (MNCA)
Legitimate Purposes of Nonprofit Corporations
 Mostly based on facts and circumstances; no bright line rules of whether a nonprofit is
allowed to incorporate
State v. Brown (Ohio 1957); illegality: if its illegal, it cannot be a proper nonprofit; practice of
nudism organization application for nonprofit status denied because nudism was not lawful;
therefore, could not form org. for unlawful purposes; state had police power to do so
Ass’n for the Preservation of Freedom of Choice v. Shapiro (NY 1961); public policy:
exclusionary, supremacist group denied right to incorporate; denied not b/c it was unlawful but
b/c it was against public policy; holding – justices and state may not arbitrarily decide which
org’s get right to incorporate and those that do not; there is a right to such activity and to
associate with each other; dissent—group has a right to meet and associate but not with the
support of the state; NB: this is an unusual outcome – brings up debate whether public policy
can be a factor; IRS rarely turns organizations down for being against public policy
 What is the difference b/w public policy and the law?
o Public policy can be the opinion of the sitting judge; defending the spirit of the
law; but not necessarily the majority sentiment
In Re Sidney Gelb Chapter for Cancer Research (NY 1959); duplicative (rare): application for
cancer research org denied b/c there were already too many cancer research orgs. in existence
and took too much money that may not go directly to cancer research; dissipates resources
People Ex Rel. Groman v. Sinai Temple (Cal 1971): commerciality; religious org. operated a
large Jewish cemetery that competed with private cemeteries and gave discounted plots to its
members; court did not consider this to be a distribution of gains, profits or dividends; allowed
to make money though; selling burial plots to pay off debt
 Problem: cemeteries is a charitable purpose; Attorney General brought case b/c of
private competitors and b/c cemetery was main purpose
 Two Issues: (1) Constructive distribution of profits; (2)
o (1) is not per se the payment of a dividend (no reasoned explanation)
 Does the nonprofit have the power to engage in activities of this kind (corporate
power)? According to statutes, yes as long as the profits go to the organization
In Re Shaw (England 1957); purposes: George Bernard Shaw left estate to an unidentified
body for the purpose of promoting the reform of the English language; this is not considered
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charity and for the public utility (“other purposes beneficial to the community”) and is instead a
task of general utility that can go to a public trust; therefore, British Museum and Royal
Academy can invalidate will and collect immediately, not just after 21 years
New York Not-for-Profit Law presents a non-exclusive list of charitable organizations for legal
non-business purposes; NY wants you to state the purposes of the nonprofit
 Type A: not-for-profit corporation including civic, fraternal, social, etc. (mutual benefit
groups); some may be 501(c)(4) orgs (lobbying, campaigning)
 Type B: non-business corporation
 Type C: lawful business purpose for a public or quasi public objective (micro-finance
organizations; low cost housing
 Type D: health care exchanges or other corporate law groups
 Restricted to non-profit purposes; non-distribution restraint; reasonable compensation
California Corporations Code:
 Public or charitable purposes, nondistribution, liability for received funds
 Nonprofit Section: money come from donors and upon dissolution have to give money
to A.G. or give their money to another public benefit organization);
 Mutual benefit under 7000 (organization are allowed to distribute their assets to their
members upon dissolution); or
 Religious organization under 9000 regime (makes it hard for IRS to conduct an audit
federally; main thing AG can go after is criminal actiity)
MNCA: Any lawful purpose; non-distribution constraint; reasonably comp.
IV.
Articles of Incorporation
General legal framework for nonprofit; generally includes name, purpose, whether or not it’s a
membership org, and the registered agents; vary from state to state; difficult to change usu. by
the board of directors unless a special provision applies
 Look to federal laws for what is required of tax-exempt orgs. and put these into articles
of incorporation
NY Incorporations Law: Include name, for public purpose; address; directors; duration; agents
Cal. Incorporations Law: directors; duration; name; declaration of public purpose; address;
MNCA Incorporations Law: MNCA doesn’t even require you to state your purposes (language
says “may”); name, address; incorporated?; name of incorporator
Queen of Angels Hospital v. Younger (Cal. 1977): Queen of Angels hospital not allowed to
rent out original hospital building in order to operate clinics throughout LA because this is not
the purpose of the nonprofit according to its Articles of Incorporation; although its intent is
good, this does not matter
 While Queen of Angels can set up clinics, it cannot abandon the hospital
 AG may have thought it was a charitable trust that AG must pursue; discourage
hospitals specifically from entering into for-profit joint ventures—hospital mergers are
big news
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V.
Bylaws
Internal rules that govern the nonprofit; provide details from the framework; rules for holding
meetings, voting on issues, electing directors and officers, and other provisions
NY Bylaw Rqmts. – adopted by incorporators == relates to business fo corporation, conduct of
affairs, powers of members, directors, or officers
Cal. Bylaw Rqmts. – similar to above; made by board setting meetings, votes, director/officer
duties; reporting and due collecting, etc
American Center for Education v. Cavnar (Cal 1978): Amyx president of ACE; other Cavnar
(VP) and Todt (VP) wanted to oust him; Amyx fled building at meeting to oust him; Cavnar
and Todt met him at bank, told him he was going to be removed from his position; Amyx
stayed and participated in discussion; Board meeting later approved this after giving notice to
Amyx of meeting; according to bylaws, procedural requisites, quorum, and meetings were all
valid
 Counter intuitive that bank altercation is sufficient according to bylaws
 Even in settings where it is okay to remove officers w/o cause, there are courts that will
add a gloss that says “yes, but not for certain reasons” (b/c he is African-American)
 Why does the court permit such informal actions? respecting freedom of K – bylaws
may suggest that you can take these actions; also, prevents a standstill for the nonprofit
CHAPTER 3. THE BOARD OF DIRECTORS AND THEIR GOVERNANCE ROLE
I.
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II.
Introduction
Directors and officers control and there are not shareholders like in for-profit corporations that
are present; owe fiduciary duty to organization
Duties: make policy decisions, supervise senior staff, and ensure that the org. remains fiscally
healthy, and that the org. stays focused on its mission
In reality, the officers actually run the directors; technically the model is top down but as a
matter of practice it is less linear
As a matter of law, the board is liable as a matter of law
In general directors can act in two ways—through a majority meeting and also through written
consent (need not be at a meeting); in almost all states there must be unanimous written consent
– why? better to make decision at a meeting
o Generally, directors cannot vote through proxy – shareholders can by the directors have
a different mandate
General Concepts of Governance
Model Act: Became less liberal, less progressive by giving away some of the responsibility;
caveat—model act in casebook is third version and not adopted in any state; revised act are the
ones that have ben adopted by different states; sets duration; election and removal;
compensation; meetings; voting; quorum; etc.
Cal. Code: similar to the MNCA; ultimate responsibility is with the board
NY Laws: min. number, election; duration; removal; quorum to made decisions; meetings and
notice; Board does not retain the liability
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Herning v. Eason
Hearning wanted to remove Eason; Herning wanted to count proxy votes but Eason didn’t
recognize the votes; a new law said voting by proxy was okay but this was not retroactive and
org. was older than new law; court says it would be confusing to go back to the original intent
and the bylaws did not expressly prohibit voting by proxy
 Why is this not a substantive law change? Court says that if its substantive, then its
prospective but here already had the right to vote
Tackney v. U.S. Naval Academy Alumni Ass’n
Alumni thought certain board members were violating the terms of the bylaws for term limits;
dispute: was term limit 6 years or 9 years?; concern was that board was becoming too insular –
number of board of directors is set; Courts will respect a reasonable and non-arbitrary
interpretation of the bylaws in the absence of express language to the contrary
III.
Fiduciary Duties of the Board of Directors (p100)
 Fiduciaries are those that have a duty to someone or something other than themselves
A.
Fiduciary Duties of Care, Loyalty, and Obedience
I.
Duty of Care—duty to pay attention to the organization; not very strict-usually requires just good faith which prevents a court from second
guessing the decision of the director on the merits – courts will look into the
rigors of the decision making process (but not too intrusive)
 Not rigorous
II.
Duty of Loyalty—reminds board members to keep the interests of the
corporation paramount and avoid benefitting unfairly from their relationship
with the corporation
III.
Duty of Obedience—emphasizes the importance of the mission; this is not
accepted in all jurisdictions; can also be put under the duty of care
MNCA §8.30 – Standard of Care for Directors: good faith and due care; disclosure;
delegate authority; reliance on experts and other employees
§ 8.32: may not loan money to director
§ 8.60: Conflict of interest does not make K void; must be disclosed to board or those
who vote, Km ust be fair
§ 8.70: Business Opportunities – director can’t take advantage of business opportunities
Mad v. Lucy Webb Hayes National Training School for Deaconesses
Concerns the fiscal mgmt. Sibley Mem. Hop. in DC; Def. trustees enriched themselves through
self-interest and breached fiduciary duties of care and loyalty in mgmt. of Sibley’s funds; class
action by patients; Corporate History: trustees were largely absent from running hospital for
almost 20 years – run mainly by Orem and Ernst until their deaths
III.
Breach of Duty of Care and Loyalty
A.
The Trustees
1.
Mismanagement: trustee held to high standard of care and
liable; director must have committed gross negl.
2.
Nonmanagement: trustees vulnerable to this b/c of 20 year
lack of mgmt.
3.
Self-dealing: may be held in breach of trust when using
bank accounts with which they are associated but most use
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less stringent standard that requires only fairness and full
disclosure; all trustees in breach of fid. duty accd. to DC Law
even though they were of minor consequence
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Requires care a reasonably prudent person would exercise in a similar situation;
o Difference b/w prudent person standard and new good faith/reasonably belief
that actions are in best interests of organization
 (1) Good Faith
 (2) Reasonably Believes in the best interest of the org.
 [(3) Exercises the Care of a reasonably prudent person] – removed in
new model code
 removed a standard that might hold the directors to a higher level of
diligence
Non-Profit Problem: there’s even less incentive to be hands-on because of the lack of
compensation; in non-profit area there’s prestige in being director in the hopes that
more money will be given but not for the purposes of directing the mission of the org.
o Proposal: have an advisory and honorific board and then have a voting board
Committee to Save Adelphi v. Diamandopoulos
suit against former president and the board because of no oversight of Adelphi and wrongdoing
II.
The President’s Compensation – must be reasonable and he must exercise due
care; no self dealing; BJR not absolute; here he was overpaid and poor
performance
D.
Factors: Failure to Exercise Due Care: informed decision making;
compensation v. performance; fair dealing
III.
The Conflicts of Interest: must further goal of org. not personal interest
A.
Adelphi’s Insurance Coverage: insurance obtained from head of ad
hoc committee on school’s insurance; failed to disclose though not in
and of itself bad
C.
The Board’s Failure to Protect Adelphi from Interested Trustee
Transactions
 Court concluded that all directors must be removed
Manhattan Eye, Ear & Throat Hospital v. Spitzer; duty of obedience requires decisions of bd.
to be faithful to purposes of org.
Board of hospital in Manhattan decided to sell hospital to set up free-standing clinic;
sought review from Supreme Court; deal must be fair and reasonable and promote the purposes
of the corp.; here, selling of hospital did not; new and fundamentally different purpose of the
original corp.; Sloan Kettering made them a good offer b/c they were having financial problems
but board has to try and fix problems;
B.
Uniform Prudent Management of Investment Funds Act (UPMIFA): duty of
loyalty; good faith and with care of an ordinarily prudent person ; expenses must be
appropriate and reasonable; must consider financial factors
C.
Fiduciary Duties to Others
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In Re Milton Hershey School Trust (Court interfering with trust; Bd. wants to diversify but
may have ill-effects on business and community – AG allowed to stop this)
AG trying to prevent the Hersey Trust from diversifying the assets from the Hershey Company;
Hershey Trust as a $2.5B controlling interest in Hershey Foods; politically unpopular move b/c
would affect price of company and community; look to original intent of donor—here Milton
Hershey had narrow intent; effect of sale of Hersey may be large; although trustee has
discretionary power of investment, court says this is not an absolute rule; not allowed to
diversify b/c the value of Hersey will never go down? I don’t think I agree with this decision
 Why prevent this? Main reason for this trust was not being served; also harm the
public interest
 Dissent: Isn’t this ahead of things? AG shouldn’t intervene during negotiations –
but shouldn’t then the deal be killed now as opposed to later after lots of
attorneys fees
Is legal regime that governs directors too relaxed?
 Sanctions are lax but once its in court the business duty of care applies; what about
indemnification and insurance
 If its outside sphere of what the director can be indemnified for, then the nonprofit can buy the
insurance that can cover those situations and therefore liability is not harsh
 These are provisions that try to remove the director from any kind of monetary sanctions
against the director
 Optional provision limiting personal liability of the director to the corporation for breach of
duty of loyalty, acts not in good faith, or purposeful acts in the articles of incorporation
Why don’t people stand up (GC or Solicitor) stand-up?
IV.
A Blueprint for Good Governance in the Wake of a Scandal: The Saga of the
Smithsonian Institution
Independent Review Committee, A Report to the Board of Regents of the Smithsonian
A.
Overview: Mr. Small, Sec. of Smith., was a terrible leader and caused distrust of Smith.;
Proglems: Conflicts of interest not disclosed; kept GC at bay; incredibly high salary and
abuse of funds
D.
Recommendations: more active board; defined roles; board w/ expertise
V.
Enforcement of Directors’ Duties: Challenges –
(1) Low standards for fiduciary duties; (2) few sanctions; (3) Limited liability of bds. and
directors; (4) nonprofits often offer to indemnify directors; (5) Low prosecution as AG only has
standing
Stern v. Lucy Webb Hayes National Training School For Deaconesses (cont’d) (court will
avoid harsh measures and will avoid damages)
What happens when you fire your directors and board? Here, trustees were not removed
but will change standards for trustees moving forward as members retire
MNCA: Director personally liable for unlawful distributions; Nonprofit may director if
individual (1) acted in good faith and (2) reas. believed actions were in best interest of org.; no
indemnification for personal benefit; may get insurance
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Standing: (1) Attorney General always has standing; (2) Direct beneficiaries often have
standing; (3) This with substantial, direct, and immediate interest in the outcome of the
litigation; private parties generally lack standing; (4) members of member organizations have
standing
 In Re Milton Hersey School: standing an issue because donors and private parties
generally cannot bring suit; no special interest in trust
CHAPTER 5. CHARITABLE DONATIONS
VI.
Issues of Donor Intent: Issues over donors intent can lead to damaging lawsuits; arises when
orgs. ignore donor wishes (Hershey) or if donor does not live up to his or her end of the bargain
(suing to get pledged gift); tainted funds from questionable sources
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1.
Tennessee Division of the United Daughters of the Confederacy v. Vanderbilt University:
Vand. wanted to rename Confederate Memorial Hall to just Memorial Hall; trial court agreed
that the school could do this; appellate court rev’d lower court and said that what Vand. alleged
are not true; not impossible to live up to terms of gift (keep Confederate Memorial Hall or give
back $50K adjusted for today’s prices; left the full-name engraved by officially changed the
name of the hall
Damages limited to recovery of the gift; conditions created by express terms
Donor Intent: Court reinforced donor intent supported by court even if gift was not fair (Vand.
had academic purpose of obtaining a racially diverse student body and faculty) (donor intent
sustained);
o Princeton case (donor intent not sustained) -- $35M gift (now $700M) to University for
government program; Princeton loose in using the gift; settlement reached in which the
family of the donor received $50m to set up a foundation that would pursue the purpose
they wanted and $40M for court fees; Princeton retained total control over $710M
o Difference: Trust document – Contract v. Bequest
o What about conditional gifts? Tax deduction is taken as part of a completed gift and
therefore you don’t have a right of reverter; charitable institutions, however, don’t
waive this right of reverter
o But seems to depend upon the size of the donation
 There are no decision rules for how to make standing doctrine
CHAPTER 6. CHARITABLE SOLICITATIONS
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State Law Requirements
o Generally apply to fundraising, fundraising consultants, and solicitors
o Covers charities, consultants, and solicitors to register with the state and file annual
reports
Model Act Concerning Solicitation of Funds for Charitable Purposes
o Charity according to 501c3 anyone who holds himself out as one
o Solicit – requires directly or indirectly for money, credit, property, financial assistance
to be used for a charitable person
o Fund raising Counsel – someone who for money counsels org. about solicitation of
funds; not including person working for individuals (lawyer, financial planner, etc.)
o Paid Solicitor – any person who gets paid to help solicit funds
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Commercial Co-Venturer – person who for profit regularly engages in trade other than
in connection with soliciting for charitable orgs
o Must register and make annual reports; there are size exceptions
o Duties of fund raising counsel to disclose role
Solicitations in the Digital Age
o The Charleston Principles: guide for states when solicitations are made online; States
have jurisdiction over orgs. that are registered within the state; based on principal place
of business; may need to register if out of state if there is much interaction and activity
in or directed at the state
o Not very well contemplated by states but may affect whether a person has to disclose to
state that they are soliciting donations from org.
o
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IV. Constitutional Issues
A.
Introduction: Supreme Court Cases; invalidated laws that prohibited charitable orgs
or fundraisers from engages in charitable solicitation if they spent high percentages of
donated funds on fundraising – whether or not fraud was involved.
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Village of Schaumburg v. Citizens for a Better Environment; Local law
mandating an at least 75/25% charitable purpose/fundraising scheme
unconstitutional; not fraud and solicitations afforded free speech protection;
preventing fraud is a legitimate gov. interest; but statute must be tailored
narrowly to promote government interest; SCOTUS said this could be better
achieved
 Why is solicitation free speech? Not only soliciting money but
advocating on behalf of their cause; money and speech equated together
Secretary of State of Maryland v. Joseph H Munson: state statute with waiver
for orgs. that could not raise funds any other way (public policy orgs) struck
down
Riley v. National Federation of the Blind of North Carolina; 3 tiered system
from NC Statute based upon type of activity of org. (advocacy, and
dissemination of information taken into account); disclosure requirement – court
hates this because this is content restriction and thus subject to strict scrutiny;
prior licensing requirement-also unconstitutional; state wanted to dispel donor
misconception and prevent fraud; the
Madigan v. Telemarketing Associates: fraud cases allowed to be tried; D hired as fundraisers
for Vietnma Vets Org; 85/15% scheme (85% goes to for-profit solicitors); AG filed suit for
fraud based on misrepresentation of donation uses; state dismissed suit despite fraud claims
based on 3 previous cases; SCOTUS picked up on more generalized statement; specific
instances of deliberate deception; made specific allegations that weren’t true
Fraternal Order of Polce, ND State Lodge v. Stenehjem (8th Cir)
Statute prohibited solicitation calls to the residences of persons who joined the state's do-notcall registry, but exempted telephone solicitations made by the organizations as charitable
entities. Exemption only applied if the solicitation by volunteer or employee of the org; did not
include professional solicitors; claimed violation of the orgs' freedom of speech.; statute upheld
by court for protecting privacy interests, being narrowly tailored, and not foreclosing alt. means
of communication.
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CHAPTER 13. ENDING THE NONPROFIT ORGANIZATION: DISSOLUTION, MERGER,
AND CONVERSION
I.
II.
Introduction: (1) Dissolve and terminate; (2) Merge; or (3) Become for-profit – what happens
to the assets?
Cy Pres and Deviation
 Cy Pres: when charity’s purpose becomes impossible, impracticable, unlawful or wasteful
to fulfill
o Rqmts: must notify regulator; then may modify the restriction in a manner
consistent with the charitable purposes expressed in any documents that were part of
the original gift
 Deviation: administrative remede, applied when the trust cannot function for an
administrative reason
o Usu. abolish distinction between the two
 Common Law: court could modify purposes of a trust if: (1) valid trust; (2) circumstance in
which the trust’s original purposes are being thwarted; and (3) donor had general charitable
intent that is broader than the donor’s specifically stated purposes so that its appropriate to
apply the trust funds to another charitable purpose
United States. v. Cerio – impossible can mean impractical
Coast Guard Academy could not accept the gift to establish engineering scholarship as is,
disrupt the purpose of the Coast Guard; Invoked cy pres doctrine: (1) valid charitable trust w/o
a gift over; (2) an existing general charitable intent; and (3) the beneficiaries must be indefinite
or uncertain or (4) the purpose of the trust must be indefinite, impossible to perform, or so
impracticable of performance as to characterize the fulfillment of the purpose as ‘impossible
 Court did backflips to give the money to the school but this was following the intent of
the donor – said general intent to help school with no designation for funds if not able to
be used
 This is deviation aka an administrative change – changed award amounts and number as
well as made it for general sciences
In Re the Barnes Foundation: Trustee of Barnes Art Collection wanted to expand investments;
and fundraisers in gallery should be permittied; Ct. says fundraisers allowed; look to donors
intent – donor didn’t want gallery to be a banquet hall; only used for fundraisers though;
deviation requires a unforeseen change in circumstnaces and frustration of purpose if obedience
is required—moving party has burden and they did not meet this
FEDERAL TAX TREATMENT OF CHARITIES AND OTHER NONPROFITS
CHAPTER 4. TAX-EXEMPT PURPOSES OF § 501(C)(3) ORGANIZATIONS
I. Introduction: Exempt from income taxes and able to accept tax-deductible donations
II. Rationales for Charitable Tax Exemption: Public Benefit Rationale
Law of Tax-Exempt Organizations: pluralism – nonprofit sector an alternative to the gov. sector -Theories of the Federal Income Tax Exemption for Charities: Thesis, Antithesis, and Syntheses
The Thesis: Traditional Subsidy Theory/Public Benefit Theory: charities provide primary
public benefits of good goods to ordinary people and ordinary goods to the especially
deserving.
Antithesis: Bittker and Rahdert’s Income Definition Theory: charities exempted because
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the income tax could only logically be levied on activities undertaken for profit; when
you give a gift, its not taxed (at least on the donee; there is a tax on the donor); its like a capital
contribution
 Under this view, Bob Jones may be able to keep tax exempt status
Hansmann’s Capital Formation Theory: when nonprofits arise as the most efficient
provider of goods and services when the normal for-profit provision fails for a particular set of
reasons
 Certain reasons for tax exemption are because of market failure:
o (1) Separation of Purchaser and Recipient of Service – trust nonprofits more to
do what they are supposed to with donation
o (2) Public Goods – undersupplied by for-profits
o (3) Complex Personal Serivdes – purchaser willb e unable to monitor quality
effectively at a reasonable cost even though the service is being supplied directly
to the purchaser
o Nonprofits are barred from capital markets; nonprofits focused on services,
businesses on profits – therefore this is a disadvantage and tax exemption allows
them some offset the loss of capital markets
Hall and Colombo’s Donative Theory: Donative nonprofits may not produce an optimal
level of output because wealth redistribution, an integral component of their output, is in some
respects a public good
 Only charitable entities that depend on donations and not fees for service may claim tax
exemption
Atkinson’s Altruism Theory
Walz v. Tax Commission of City of New York
 Landowner in NY sought injunction to prevent NY Tax Comm’r from granting property tax
exemptions to religious org; SCOTUS held that there was no nexus between tax exemption
and the establishment of religion and that federal or state grants of tax exemption to churches
did not violate the First Amendment; the grant of a tax exemption was not sponsorship of the
organizations because the government did not transfer part of its revenue to churches but
simply abstained from demanding that the churches support the state. The exemption created
a more minimal and remote involvement between church and state than did taxation because
it restricted the fiscal relationship between church and state and reinforced the desired
separation insulating one from the other.
o Dissent says exemption is a subsidy
III. Introduction to Section 501(c)(3)
A. An Introduction to the Statute and its Regulations
Internal Revenue Code § 501
i.
501(c) is part of a list – exemption comes from 501(a) – (c)(3) is described in
501(a)
ii. Conditions: Corporation or community chest foundation; org. and operated
exclusively for
1. Entity: Corporation or Community Chest, fund, or foundation
2. Organization: refers to organizing documents (formalistic)
3. Operated: regard primary activities that accomplish one or more of the
causes in 501(c)(3) – religious, charitable, scientific, public safety, literary,
educational purposes, amateur sports, prevention of cruelty to children or
animals
4. Exclusively – interpreted as primarily by IRS
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a. May do more than just the designated purpose so long as its less than
a substantial
b. Non-501(c)(3) purpose has to be less than substantial
c. Purposes: religious, charitable, scientific, testing for public
5. Private Inurement Test – kind of private benefit that goes to an insider of the
tax exempt; No insider can get a private benefit
6. Non-lobbying Constraint – no substantial part
7. Political Campaign Constraint
8. Dissolution – Upon dissolution, revenues and donations will go to
government or another 501(c)(3)
Treas. Reg. 1.501(c)(3)-1(d)(1)(i)-(ii): Lists above charitable purposes; must also operate
for public rather than private interest
o Org. must establish that it is not organized or operated for the benefit of private interests
such as designated individuals, the creator or his family, shareholders of the
organization, or persons controlled, directly or indirectly, by such private interests.
Treasury Regulations §1.501(c)(3)-(2) – enumerated list of charitable purposes p163
B. Organizational and Operational Tests
i.
Organizational Test: Looks to language of founding documents – must have
language specifying charitable/exempt purposes; state assets will continue to be
used for exempt purposes upon dissolution, and refrain from countering other
requirements
ii. Operational Test: Looks to how org. is run; must be operated primarily in
activities which accomplish one or more of its exempt purposes
IV. “Charitable” and the Public Policy
A. The Bob Jones University Case – questions of purposes of tax exemption, meaning of
charitable, public policy questions, roles of congress, courts and IRS
Bob Jones University v. United States; public policy question; unique case – odd pub. pol.
test
 Schools discriminated racially in admissions – exemption removed; 1971 IRS made
revenue ruling that any racially discriminatory schools could not be tax exempt
o Any charity has to meet two requirements:
 (1) Charity must provide a public benefit
 and (2) And in doing so, the charity must not violate public policy
 Public Policy against racial discrimination in education
o How do we know what public policy is? look to acts of Congress, statutes,
executive orders – here, public policy is clear; but otherwise hard to meet
o IRS may not change scope of Congressional law
B. The United States Response to Charities with Suspected Terrorist Ties: 501(p) allows
IRS to suspend exempt status of any org. that is designated a terrorist org.; Due Process
requirements relaxed—does not talk to denying tax exempt status though
i.
Legal Battles of Charities on the OFAC List – list of terrorist orgs.
ii. Prohibitions on U.S. Charitable Involvement with Terrorist-Based Organizations
iii. How Susceptible are Charities to Terrorism?
V. Section 501(c)(3) Purposes: Health Care
A. Health Care as a Charitable Purpose
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IHC Health Plans, Inc. v. Comm’r of Internal Revenue
 Legal Standard for Tax Exemption Cases: (1) does activity confer a public benefit
rather than serve a private interest or (2) must determine whether the organization
operates primarily for this purpose
 For Hospitals, what is “for the community benefit” – IRS standard depart from pure
services for the poor; also include educational benefits, research, etc.
 Here, court applies test: health care provider must make its services available to all
in the community plus provide additional community or public benefits; public
benefit must be the primary benefit of the organization
o If all clients pay premiums to get benefit (based on risk factors), this isn’t a
non-profit model
o Orgs used risk-bearing function to set prices; this is not a non-profit
 Selling at a discount and selling below cost is different
o Lowering margins (“at a discount”) doesn’t mean they aren’t making money
Testimony Before the Full Committee of the House Committee on Ways and Means,
Colombo – Community Benefit Std. is a disaster for healthcare b/c it lacks accountability;
providing health care is a community benefit and thus definition is too broad
Testimony Before the Committee of the House Committee on Ways and Means, Horwitz –
nonprofit hospitals provide essential, unprofitable se4rvies that are valuable to society and
are driven by results, not profits
B. Is Change Afoot for Tax-Exempt Hospitals?
The Pension Protection and Affordable Care Act of 2010
 Community Benefits Assessments must be conducted every three years and with
input from the community
 Hospitals must est. financial assistance and emergency medical care policies
 Cannot bill patients who qualify for financial assistance at inflated rates – hospitals
have master charge set of amounts for procedures but have special rates for
insurance companies – may no longer do this, must determine what they will charge
to non-insured
 Cannot undertake extraordinary collection actions
State Law Pressures: The Provena Hospital Case – new parameters for community benefit
standard
Review of Exempt Status:
 Must be in the category mentioned or otherwise provide a public benefit
 Cannot violate strong, clearly national public policy even if they fit first requirement will not be
deemed charitable for 501(c)(3)
 Cannot engage in illegal activities – problematic with immigration bills
 Private Benefits – even if an entity is completely charitable, if the org. has a greater than
insubstantial private benefit, this will make it ineligible for 501(c)(3); also includes private
inurement (insiders)
 Too much lobbying
VI. Section 501(c)(3) Purposes: Disaster Relief
 IRS, Disaster Relief, Providing Assistance through Charitable Organizations
o Aid to Individuals
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o Aid to Businesses
o Charitable Classes
 Class must be indefinite; goes to the idea of public benefit
 Big class may not necessarily be charitable
 Must be indefinite, and needy
o Needy or Distressed Test
o No Automatic Right to Charity Aid
o Short and Long Term Assistance
o May earmark donations for particular purposes in order to help specific people; okay
because it gives the discretion to the nonprofit
VII. Section 501(c)(3) Purposes: The Concept of “Charitable”
 When charities do not fit clearly into the separate categories of exempt organizations
 (1) Environmental Protection – preserving back acres of farm to avoid suburban creep
o What would make this a valid charitable trust? If its ecologically significant and
undeveloped – endangered species, make public benefit to have the ability to come
enjoy or study it
 (2) Addressing issues of significant public importance or the economic benefit of person who
comes to you?
o Okay to serve a private benefit if its incidental; but fees – may accept attorneys fees if
awarded but amt. received is not to exceed half of operating budget
VIII. Purposes: Educational Organizations
 Challenge: Determining the boundary between education and propaganda
o “Full and Fair Exposition Test” Big Mama Rag (1980);
 “edu. org. must present a sufficiently full and far exposition of the pertinent
facts to allow formation of individual opinions
 found to be imprecise, arbitrary and vague; unconstitutional
o “Methodology” Test; Nat’l Alliance (1983); aff’d by Nationalist Movement (1994) –
Rev. Rul. 86-43 codified this
 IRS looks to the method used to develop and present its views; must provide a
factual foundation; factors disproving educational purpose if:
 (1) viewpoints unsupported by facts is a substantial portion of
communications; (2) facts are distorted; (3) use inflammatory or
disparaging terms that appeal more to emotions; (4) not aimed at
developing an understanding on the part of the intended audience (does
not consider background or training of reader in the subject matter);
 IRS will look to all facts and circumstances and there may be exceptional
circumstances; added to enlarge the sphere that would qualify as exempt
o Operational Test: examines the actual purpose for the org’s activities and not the nature
of the activities or the org’s statement of purpose
 (1) Org. must be primarily engaged in activities which accomplish exempt
purposes; (2) org’s net earning must not be distributed in whole or in part to the
benefit of private SH or individuals; (3) org must not be an ‘action’ org – one
that devotes a substantial part of its activities attempting to influence legislation
or participate indirectly or directly in political campaigns
 Treasure Reg. §1.501(c)(3)-1(d)(3)
o Instruction of individual for purpose of improving or developing his capabilities; or
institution the public on subjects useful to the individual and beneficial to the
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

community; may argue a specific viewpoint if it presents a sufficiently full and fair
exposition of the pertinent facts as to permit an individual or the public to form an
independent opinion or conclusions
American Campaign Academy v. Comm’r - operational test; private benefit to republicans
o Campaign school that favored Republican students who went exclusively to Republican
campaigns
o Applies Operational Test: examines the actual purpose for the org’s activities and not
the nature of the activities or the org’s statement of purpose – who does org serve? who
benefits?
 Presence of Private Benefits – benefitted Rep. candidates; Rep. party is huge
group of people therefore public in nature?
 Size alone fails to confer charitable status; candidates must be part of
charitable class – must need a class in need
 Secondary benefits which advance a substantial purpose cannot be
construed as incidental to the org’s exempt educational purpose
 If the activity is partisan, then its private
o Here, secondary purpose is substantial and therefore part of
primary purpose
 Question of who the org. serves and who benefits?
Nationalist Movement v. Comm’r -- methodology test; supremacists not supported by facts
o White supremacist edu. org. through spokespeople, supporters, and other means of
disseminating info, petitioner advocates social, political, and economic change
o “Full and Fair” Regulation -o Methodology Test: see above
 Because it focuses on methods and not the speech itself, not infringing free
speech; cop out?; does not chill speech
 (1) facts? no, appeals to common sense and uses unsophisticated language
 (2) distorted facts? exaggerating threats against members
 (3) inflammatory language? queers, perverts – not too inflammatory
 (4) Does not consider background or training of reader in the subject matter?
 Education is not the same; depends on your audience – this is young
people so we expect their content to take into account the level of their
readers (not to use ‘queer’ etc.)
IX. Purposes: Religious Organizations
 Churches different than religious orgs; challenge of diving into religious beliefs;
o churches get add’l favorable tax treatment – no need to apply for exempt status, no need
to file annual 990; automatic public charity status, more protection from audits
 Holy Spirit Ass’n v. Tax Commission: religious activities? bona fide?
o Korean religious org. in property tax dispute; dispute over whether church was
organized primarily for religious purposes – bona fide religious purpose?
o State found political and Economic aspects of religion too dominating – Unification
theory that all aspects of life must be used to promote faith, reverend Moon believes
that he is the Messiah and conquering the world of his ideas? Okay if its part of the
religion; demonstrated sincerity of the beliefs
o (1) Are activities religious (2) and are beliefs bona fide? Here, doctrine clearly set
and well accepted and the members practice and believe this so its bona fide
o State cannot determine what is religious and what is not; exemption reinstated
 Church of the Chosen People v. US – belief test; gay imperative not full belief system
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
o Gay Imperative – ever increasing numbers of persons expand their affectional
preferences to encompass loving gay relationships
o Not a religious org – limited members, not trained, no gathering spot, money collected
paid for personal expenses
o Test: (1) Beliefs address fundamental and ultimate questions concerning human
condition (2) beliefs are comprehensive in nature and an internal system of belief
and not an isolate teaching and (3) whether the beliefs are manifest in external
forms
 This org. only had to do with sexual preference; no history, literature, no origin
story
Foundation of Human Understanding v. US – church test – 14 factors; not congregationalist
o Church v. Religious Entity; exempted as a Church but in 2000, IRS revoked exemption
as a Church because the nature of the organization changed over the years – became
less centralized
 Church is a narrower concept of religion – church is a house of worship
 Whether they have preferred status of religious attributes
o Two Methods:
 14 criteria test (see n2, p240-41); congregation spread out that did not meet
regularly and used technology to connect
 Associational Test under 170 – may be treated as a religious org as long as
there is a body of followers beyond the scope of a family church who seek
the teaching of the org. and express or acknowledge an affiliation with its
religious tenets.
 only two of the criteria of 14 factor test – still denied status
X. Other Purposes: Scientific, literary (educational), prevention of cruelty to animals, amateur sports,
public safety testing purposes
XI. State and Local Charitable Tax Exemptions
A. State Income Tax – by statute
B. Sales and Use Taxes – vary state to state; not at universal as income tax exemption
C. Property Taxes – look to charitable purpose of org. but also determines whether charity
uses the property for exempt purposes; fair for orgs. to use water, utilities but not pay city
for them?; orgs. may make payments in lieu of taxes (PILOTs)
CHAPTER 5. CHARITABLE CONTRIBUTIONS
I. Introduction
a. Pension protection act of 2006: Elderly allowed to contribute directly to charitable
organization from IRA
b. Only 70% of households itemize, therefore there’s no incentive to deduct
c. Worry of rich people getting a bigger break
II. Rationale for the Charitable Deduction
a. Public Benefit Theory; Income Tax Theory; Political Philosophy Theory
b. The Marketing of Philanthropy and the Charitable Contributions Deduction: A reward for
altruism, particularly for corporations? Favors big donors supporting particular orgs.
c. Not All Charity Is Created Equal: Money flows to too few diverse organizations
d. Charitable Explanation: Charity gap is driven by values—religious people give more?
III. Who or What is a Proper Recipient of a Charitable Gift?
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a. IRC § 170: Charitable Contributions and Gifts: a contribution or gift to or for the use of
qualifying entities that is deductible from the donors income
i. There is a cost to giving but this is softened by tax-exemption
ii. You get charitable contribution deduction
1. Individuals can give 30% (private foundation) of adjusted gross income or
50% (public charity) depending on organization
a. Private operating foundation – instead of family foundation, it’s a grant
giving foundation (50% rule)
2. Carry forward – if you exceed the amount in one year, you can carry it over to
the following year (for up to 5 years)
iii. To Whom: gift has to be made to United States charity; for individuals you can’t give
to foreign charities unless they get exempt status under US Code; all recipients of US
company, have to file regular reports
b. Idea of tiered contribution giving?
i. Encourage to give more to social services?
IV. What is a Charitable Gift
a. United States v. American Bar Endowment – contributions must be purposeful
i. ABE is the fundraising arm of the ABA (ABA is was 501(c)(6) so non tax exempt);
fundraises by providing group insurance policies to its members; low insurance rates
because of healthy lawyers; ABE gives dividends of policy holders directly to ABA
ii. Rule: (1) Donor may claim a deduction for the difference between a payment to the
charitable organization and the market value of the benefit received in return; (2)
excess payment must be made with the intention of making a gift
iii. Here, policy holders did not purposefully contribute dividend; no deduction
iv. Pl. could not prove that they could qualify for a cheaper plan
1. If there was a plan for $750 and the policy holder still paid $1000 b/c they
intended for surplus to go to charity, this would have been okay
b. Hernandez v. Comm’r of Internal Revenue – no quid pro quo (reciprocity) for
contributions; reversed laster
i. No deductions for payments made to Scientology to receive services known as
auditing and training
ii. Test has come down to an expectation of quid pro quo
1. Contributions must be made without adequate consideration to get something
in return (set contributions/payments for religious services)
iii. Dissent: there has never been a case that the IRS has decided a case on the quid pro
quo case; too difficult to establish market value of these church services
1. IRS should not be able to decide what the court qualifies as a religion or not; if
you allow deductions for tithing, or high holiday seats – you do it for everyone
else (avoids entanglement)
iv. Also, there’s a revenue ruling saying that contributions of goods to church are tax
deductible; Hernandez said that this is an inconsistency (discrimination on basis of
religion)
c. Sklar v. Comm’r
i. Sklars are trying to take tax deductions for 55% of their children’s education at a
religious school
ii. Contribution or gift?
1. Petitioners rely on Scientologists – saying they were exempt for offering their
services (another discrimination claim based on Hernandez)
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a. Ct. says that we don’t know if this is true but this is not what we’re
decided today – will not follow the closing agreement
2. No—getting something in return
iii. Dual Payment—payment made in part in consideration for goods and services and in
part as a charitable contribution; must deduct the amount of the benefit from the
market value of the contribution
1. Market value here is the cost of a private education – so no deductible benefit
iv. Religious Patchwork –
1. Religious Education – always been that you can’t take charitable contribution
deduction;
V. A Brief Overview of Other Charitable Contribution Issues
a. Amount of Deduction: Donations only tax deductible to the extent that the fit exceeds the fair
market value of any goods or services received in return
b. Services: value for donating time not deductible
c. Timing of Deduction – deductible in the year it was made
d. Unconditional Gift: Only deductible if gift is given unconditionally
e. Percentage Limitations and Carryovers: Deductions for contributions can only be a certain
percentage of individual’s income
f. Substantiation Rqmts.: Must get written acknowledgement from org.
g. Noncash Contributions: In kind donations—ordinarily limited to the fair market value of the
good
CHAPTER 9. INUREMENT, PRIVATE BENEFIT, AND EXCESS BENEFIT
TRANSACTIONS
I. Introduction
a. Inurement—a type of private benefit; involves the insider or a private shareholder
i. Easier for IRS to get this charged; there is absolutely no amount of inurement
here
b. Private Benefit
i. Some private benefit as long as it is incidental and not substantial is okay
II. Inurement
a. Treas. Reg. 1.501ce-1c2, 1.501a-1c No part of the net earnings of which inures to the
benefit of any private shareholder or individuals (insiders) – results in loss of exempt
status
b. United Cancer Council v. Comm’r – inurement comes down to control
i. UCC raising money through Watson & Hughey; lots of money went to W&H;
lower court found that net earnings inured to the private benefit of the
fundraising company ($26.5M or $28.8M raised!)
ii. Tax court found W&H was an insider; court disagreed and found no inurement
1. Go through process; who has the control of the decision making process
iii. This is an impermissible judgment on the running of UCC; UCC retained
control, W&H was not an insider (they were later non-renewed on a K) and
therefore inurement was not triggered
iv. Enough of a threat that this was going to come out the other way after being
remanded that it was settled – look to specific arrangement
III. Private Benefit – broader than inurement; applies to anyone (not just insiders); but incidental
private benefit is allowed – results in loss of exempt status
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a. Treasury Reg. – org cannot be org. or operated for benefit of a private interest of a
individual, creator, family, SH, or controlling parties
b. American Campaign Academy v. Comm’r
i. Campaign school so unfairly favored Republicans that the court found a private
benefit to Republicans; persons do not have to be interested (as in inurement)
IV. Intermediate Sanctions, Excess Benefit Transactions
a. I.R.C. § 4958
i. Polices self-dealing transactions
ii. Analytically – (1) is he a disqualified person – watch if someone has large
influence but is no longer an officer (founder, etc), test or control over decision
making
iii. Must be corrected – so the excess amount must be paid and he must pay 25% tax
on the excess benefit for director (10% for mgmt. staff); if not corrected then
there is a 200% penalty
iv. See hypotheticals 4958 Questions
v. Even if the IRS imposes an excise tax under 4958, it doesn’t preclude the IRS
from invoking exemption under inurement; 4598 deals with excess benefit
b. Easier Compliance is Goal of New Intermediate Sanctions
i. Regs. only apply to 501(c)(3) and (4) Orgs.
ii. Sec. 4958 Only apples to certain influential or disqualified purposes – directors,
family memebers of disqualified person, 35% controlled entities of a disq.
person – lasts for 5 years
iii. Persons Who are not disqualified – employee who is not highly compensated
($110K min.)
iv. Other persons are subject to a facts and circumstances test (look to substantial
influence)—founder; substantial contributor; control substantial part of org;
controlling interest
1. Does not include independent K, person who takes vow of overty; direct
supervisor of disqualified person; one with no control
v. Sec. 4958 Only apples to excess benefit transactions of disqualified persons
vi. Compensation provided by tax exempts is not excessive if ‘reasonable’
vii. Written intent required to treat benefits as compensation
viii. Disregarded benefits
ix. Special exception for initial contracts
x. Tax-exempts can create a rebuttable presumption of reasonableness
xi. Special rebuttable presumption rule for non-fixed payments – follow formalities
for setting compensation (BJR)
xii. The IRS has the burden of overcoming the presumption
xiii. Orgs not establishing presumption can still comply with Sec. 4958
xiv. The excess benefit usu. occurs on the date the disqualified person receives the
benefit
xv. Excise taxes under Sec. 4958
V. Relationship Between Inurement and Intermediate Sanctions
a. Treasury Reg. § 1.501(c)(3)-1(f)(2) – if subject to excise tax under 4958, comm’r may
still revoke exempt status of org.; will consider size and scope of org. regular activities
based on exces benefit transaction; size and scope of excess benefit; repeaed excess
benefit trasnactions; safeguards?; excess benefit corrected?
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ADVOCACY ACTIVITIES
CHAPTER 11. LOBBYING AND POLITICAL CAMPAIGN ACTIVITIES
I. Introduction – influencing legislation (501c3)
a. Three Models for Lobbying –
i. Public non-electing charities (disregard 501(h); standard is no substantial part)
ii. Electing (under 501(h)) – attempt to elaborate what means no substantial part
but this favors the taxpayers
iii. Private Foundations – no lobbying allowed at all; if its true for a private
foundation, these definitions can be elected into the public non-electing charity
1. Exceptions to lobbying
b. Absolute bar on political campaigning – but problem is figuring out candidate,
campaign, etc. is difficult
c. Org. cannot carry out a substantial amount of lobbying or campaigning (use the 501(h)
test)
II. Lobbying – 501h
a. The Lobbying Law is More Charitable Than They Think (Berry)
i. H Election -- 20% of money may go to lobbying; only requirement is to keep
track of the money in case of an audit; many remain unaware of the law
III. Lobbying Restrictions: Constitutionality
a. Christian Echoes Nat’l Ministry v. US – applying no substantial part standard
i. Church wants refund of taxes based on the IRS revoking their tax exempt status
for participating in lobbying; maintains religious broadcasts as part of their
campaign for spiritual welfare – specifically supporting legislation that would
allow prayer in public schools
ii. 1st Am. Argument: government may not determine what activities are religious
or political
1. But, gov. was acting to maintain wall separating church and state so Free
Exercise Clause does not apply; revoking status does not inhibit free
speech
iii. 5th Am. Argument: denied right to due process b/c arbitrarily selected the
church from other similar orgs
1. church must show discrimination based on differences of religion, race,
politics, or an unacceptable classification, this is not apparent here
b. Regan v. Taxation With Representation of Washington – have c(4) alternative; leg.
intent
i. Federal taxation lobbying group; claimed prohibition against substantial
lobbying is unconstitutional
1. Denying tax deductions for lobbying infringes on freedom of speech
2. Here, Congress is not denying the right to speech, they are just choosing
not to subsidize it – see Cammaroano v. US
3. Not subsidizing speech is not infringing it either
4. Comparison to Veterans Orgs is not a good one – Congress chose to
make an exception based upon the nature of veterans’ status
ii. TWR was an org. that began when two other orgs. combined; two orgs., one tax
exempt and one a lobbying group who influenced legislation
iii. Congress explicitly did not combine the two under the 501(c) statuses
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iv. Concurrence is the holding. Tension that was relieved by subsequent decisions
have labeled the reasonbing of the concurrence
1. Must have a c3, c4 lobbying
v. Majority didn’t insist on the right to have the alternative to a connected c4 under
the direction and control of the c3
vi. a 501c3 organizations right to speak is not infringed b/c it is a free to make
known its views on legislation through its 501c4 affiliate within losing tax
benefits for its nonlobbying activities.
1. Very important
IV. Lobbying: No Substantial Part Test
a. Slee v. Comm’r – qualitative standard; later rejected
i. Slee made donations to American Birth Control League – could this be
considered a charitable contribution; court must determine if the League is
advocating for the repeal of laws; Board determined that it was and court was
not able to say otherwise and affirmed the decision
ii. American birth control league not entitled to a charitable exemption b/c it
disseminated propaganda to legislators and the public aimed at the repeal of law
preventing birth control – not exclusively chartable, educational or scientific
iii. Political agitation as such is outside the statute, however innocent the aim,
a. Bad v. Good Lobbying – if it promotes your charitable purpose,
lobbying to do this is okay; bad is if they’re trying to change
people’s opinions
b. Trying to change world view must be made without public
subsidy
i. Here, Hand addresses the type of lobbying (qualitative)
not the amount (quantitative) – when lobbying laws were
codified, Congress used a quantitative standard not a
qualitative
b. IRC § 501(c)(3) – quantitative standard
i. no substantial part of the activates of which is carrying on propaganda or
otherwise attempting to influence legislation – the rest of 501(c) orgs. can lobby
their little heart out
ii. Who Does This Apply To?
1. If student newspaper lobbies, the Univ. is not lobbying b/c the school
didn’t authorize it
2. Someone of the org
iii. What?
1. Direct contact with lawmakers
2. Urging the Public to Contact law makers (grassroots lobbying)
3. Advocates the adoption or rejection of legislation (narrowed by the
description of legislation)
iv. What is measured?
1. Forms of communication either directly or indirectly or the third vague
standards
v. Examples – if you lobby the Senate to ratify or not ratify a treaty or to confirm a
nominee, these are acts of congress and thus lobbying
1. Even if its not a bill but it’s a legislative proposal
vi. Not lobbying
1. Lobbying administrative agencies
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vii. Exceptions – gleaned from rev. rulings things that are not lobbying:
1. non partisan communications
2. exception for discussion of broad social issues
3. providing technical assistance to a legislative body
4. Self defense lobbying
viii. How much is too much?
1. We don’t know – one case 5% of total budget is not substantial; another
case where 16% of budget was used for lobbying (anything over 15% is
substantial)
2. Christian said that it wasn’t strictly based on money but also activities
ix. Tax Exempt Joint Ventures
1. Partnership Tax – for exempt organizations
2. Pass through taxation
c. Treasury Reg. §1.501(c)(3)-1(c)(3) – influence leg. means to contact or urge public to
contact legislator or to encourage to accept of reject particular legislation
d. IRC § 504 – 501c3 who lose exempt status b/c of lobbying may not then be treated as
501c4
e. IRC § 4912 – tax on disqualifying lobbying expenditures –
i. Penalty of 5% paid by org, 5% paid for by manager if they knew it was subs.
lobbying; does not apply to orgs. opted into 501h
f. Christian Echoes National Ministry v. US- broad def. of lobbying
i. Same case as before – religious org. that engages in substantial activity aimed at
influencing legislation is disqualified from tax exemption whatever the
motivations
ii. District Court Used Narrow Standard: need specific legislation before Congress
1. Supported the Becker Amendment for prayer in public school – narrow
interpretation would require actual legislation before Congress
2. Court disagrees with this, looks more closely at the statute-- lobbying
may include asking congregation to write to congressmen, support
amendments, etc. even w/o the mention of specific legislation; looked to
publications; looks whether lobbying is core to the organization
V. Lobbying: § 501(h) Expenditure Test – only about 2% of orgs opt in to 501(h) test; Congress
may hope to raise these amounts – recommended proposals also include getting rid of grass
roots; Non-electing organization may make election at any time however you can’t revoke it at
any time
a. Enables org. to be judged by an expenditure standard
i. Expenditures by lobbying / expenditures of organization
ii. Different scale for grass roots – this is low and may be too constraining
b. The Elements of the Test – sliding scale test
c. Special Features – very precise definitions what is v. what isn’t grassroots lobbying
d. IRC §501(h): sliding scale expenditure limit for orgs. that opt in for legislation and
lobbying – difference w/ grass roots organizin; special orgs. it applies to
e. Grass Roots Lobbying (Treas. Reg. 56.4911-2) – defines grassroots lobbing—targets
general public as opposed to legislators; encourage public to get in touch with
legislators or take certain voting actions
f. IRC § 4911
23
i. Influencing legislation doesn’t include putting forth nonpartisan study; giving
technical advice; testifying
ii. Legislation – acts, bills, resolutions, items of congress, state, local council, or
similar governing body, public referendum, initiative, etc.
iii. Organization will do research and compile a report and this will be used as
evidence that they should support or not support a bill
1. Should the lobbying intent embedded in the ultimate use count as
lobbying?
a. Under 501(c)(3) – its up to the discretion of the board
b. Elect – 6 mo. rule; if lobbying use is made more than six months
after use was compiled, this is not lobbying
g. If amounts are exceeded, penalty tax equal to 25% of excess – won’t result in loss of
exemption unless it exceeds the lobbying limits by more that 150% over four years
If the exempt purpose
expenditures are
The lobbying nontaxable
amount is
Grassroots non-taxable
amount
Not over $500K
20% of the exempt purpose
expenditures
5% of exempt purpose
expenditures (or 25% of
lobbying nontaxable
amount)(up to $25K)
$500K - $1M
$100K plus 15% of excess of $25K + 3.75% of excess
exempt purpose expenditures over $500K
over $500K
$1M - $1.5M
$175K plus 10% of the
$43,750 + 2.5% of excess
excess of the exempt purpose over $1M
expenditures over $1M
$1.5M - $17M
$225K plus 5% of the excess
of the exempt purpose
expenditures over $1.5M
$56,250 + 1.25% of excess
over $1.5M
Over $17M
$1M
$250K
VI. 501(c)(4) Organizations
a. IRC 501(c)(4) –
i. Social Welfare. Civic leagues or organizations not organized for profit but
operated exclusively for the promotion of social welfare
ii. Local associations of employees, the membership of which is limited to the
employees of a designated person or persons in a particular municipality
and the net earnings of which are devoted exclusively to charitable, educational,
or recreational purposes
b. Treas. reg. § 1.501(c)(4)-1 – expands on IRC above
VI. Political Activity -- Fact based inquiries
a. No political activity is permitted but what constitutes a political candidate?
24
b. IRC 501(c)(3): does not participate in, intervene in (publishing or disturbing of
statements) any political campaign on behalf of (or in opposition to) any candidate for
public office
i. can involve writing or anything out in the open; for or against; public office;
candidate
c. Treasury Reg. 1.501(c)(3)-1(c)(3)(iii): No direct or indirect intervention; in political
campaign; for candidate for public office
i. may not publish or distribute written or printed statements or make oral
statements on behalf or in opposition to
1. Candidate can be someone proposed by others; different from other defs.
(see FECA for example); someone testing the waters?
2. Someone deciding whether they will be a candidate (polling)
3. Elective public office
d. Rev. Rul. 78-248 – voter education activities sometimes may not be considered political
activity (non-partisan activities i.e. neutral presentation of voting records, broad issues –
single issues may be considered political_
e. Rev. Rul. 80-282 – intervening in campaigns -i. Not political intervention because it was not going to be widely distributed to
the electorate and presented voting records not targeted towards a particular
candidate or campaign
1. Bad Facts – format and questions are not neutral;
2. Good Facts – small scale, monthly newsletters to a few members
nationwide
3. GCMs- General Counsel Memorandum – written on lots of subjects esp.
when rev. rulings were being considered
f. Rev. Rul. 2007-41
i. Voter Registration can be okay if neutral and general
ii. Org. leaders may not make political statements at org. events or in publications
iii. Candidate appearance must include invitations to all candidates, no fundraising,
no indication of support; nonpartisan questions; issue advocacy must not be
targeted at candidate, business activities, web sites
iv. Web Site: excpetion – if 501c3 is linking to the homoe page of 501c4, IRS,
will not investigate or audit those links regardless on the c4’s website
1. why? b/c considering the regan implications
v. No bright line rule but there are good facts and bad facts
g. Sanctions –
i. 4955 -- 10% tax on org for expenditure; 2.5% on mgmt.; more if not corrected –
expenses are for speeches, travel expenses, polling, etc.
ii. Political Activities Compliance Initiative (PACI) – education campaign by IRS
to inform non profits of the rules about political activity
h. Branch Ministries v. Rossotti:
i. Church ran adds saying not to vote for Clinton (full page add in nat’l
newspapers); referral made about political activity and exempt status threatened
1. Status as church does not preclude revocation of tax exemption;
2. First Amendment Argument – no free exercise argument because church
could set up 501c4 or 527 (alternative means for political speech)
VII. Other Tax-Exempt Orgs Engaging in Political Activity – 501c4 and 527
a. 501c4 –primary purpose of these must be to promote social welfare (promoting the
common good, civic betterment, social improvement)
25
i. Most are action orgs. that can participate in unlimited legislative activities that
are geared towards orgs. mission – still not allowed to participate in political
campaign – donors need not be disclosed (Attractive to corps.)
ii. 501c3 ass’d with 501c4 must be careful to keep entities separate
b. 527 - disclosure of donors; purely political and income tax exempt; donations not tax
deductible; must engage in purely political/campaign activities
c. PAC – hard money can go directly to candidates, unlimited donation amt.; must register
VIII. Other Regulation of Political Activity – FECA
a. Federal Election Campaign Act – places limits on campaign contributions and requires
disclosure of donors; created FEC; public funding for electoins
Org. Type
Run Candidate
Ads?
501c3
501c4, c5, c6
N
Y
PAC
Yes – purpose of
org.
Y
527
Direct
Contributions to
Candidates?
N
N (although may
be in dispute)
Y
N
Fundraising
Limits?
Disclose Donors?
Y
N
N
N
N – given
Speechnow.org
N
Y
Y
COMMRCIAL ACTIVITIES AND UNRELATED BUSINESS ACTIVITIES
CHAPTER 8. RAISING FUNDS FROM COMMERCIAL ACTIVITIES
I. Introduction
a. Problem: unfair competition and undercutting the prices but this does not happen; they
may use this to support their services
b. Should exempt status be lost? Should UBI be taxed? Is there a commercial hue?
c. UBTI – tax profits for unrelated business activities from trades or businesses that are
regularly carried on and not related to org’s exempt purpose to level the playing field
d. Two Doctrines
i.
Emphasis on the Final Destination of the Money
ii. Nature of the Purpose of the Org.
1. Subset—its the way the for profit carries out this purpose
II. Nonprofit Commercial Activity: Policy Considerations and Statistics
a. Policy Considerations
i.
The Pitfalls of Profits, Burton Weisbrod
1. Concerned about commerciality of nonprofits; YMCA too successful?
b. Statistics on Commercial Activity in the Charitable Sector – 2/3 of rev. comes from fees
and services b/c lessened support from gov. and individual giving
III. 501(c)(3) Considerations about Commercial Activity
a. Statutes and Regulations – nonprofit that has commercial operations
i.
IRC 501(c)(3) – doesn’t really say anything about commerciality except the
word exclusively
ii. Treas. Reg. 1.501(c)(3)-(1)(c)(1) – only engages in activities related to its
exempt purposes; activities mean those reflective of exempt purposes – or
26
those activities that are more than an insubstantial part of its activities not in
furtherance of an exempt purpose
iii. Treas. Reg. 1.501(c)(3)-(1)(e) – org. may operate trade or business as
substantial part if in furtherance of exempt purpose and business is not
primary purpose of org.
1. Think of Am. Campaign Acad.
b. Commerciality Doctrine
i.
Operational Test: (1) activities are primarily for exempt purposes; and (2)
non exempt activities are not substantial
ii. What are the purposes of the org and to who does the benefit inure?
iii. Better Business Bureau of Wash. DC v. US (U.S. 1945) operational test
1. Pl. lost exempt status because it had substantial purpose of promoting
profitable business practices; No tax-exemption because the mutual
welfare, protection and improvement of business methods among
merchants – there were other exempt categories specifically for trade or
business ass’ns
2. The presence of a single non-exempt purpose substantial in nature will
destroy the exemption
iv.
Presbyterian and Reformed Publishing C. v. Comm’r of Revenue (3d Cir.
1984); success does not mean revocation
1. Nonprofit publishes niche religious books and became very successful;
did P&R acquire a commercial hue because of the success?
2. Issue: When does the successful operation of a exempt org. deem to have
transform into commercial enterprise?
3. Test: (1) What is the purpose of an organization claiming tax-exempt
status; and (2) to whose benefit does its activity inure?
a. Look to the commercial hue – the way the activity is carried out
4. Neither of these factors indicate the presence of a non-exempt purpose
5. The success of an organization should not call into question its exempt
status.
a. Accumulation of profits may be a problem but the org. must then
prove that the surplus was used for its non-exempt purposes –
constructing a larger warehouse
v.
Airlee Foundation v. IRS (D.D.C. 2003) – manner in which the org. was
operated makes a difference; if there is a substantial nonexempt purpose,
you’re not entitled to exemption – both commercial hue
1. Airlie operates a conference center for educational purposes; IRS says
revoked exempt status commercial hue – competes with conference
centers in DC – 40% of clients private
2. Engages in both an exempt and business purpose – is it primarily for
exempt purposes?
3. Fee Structure and subsidization practice may favor org. – nature of
clients and competition, advertising and substantial rev. from non
exempt purposes favor IRS
vi.
Ultimately, there is no bright line rule and the court goes in phases. Look
at how your jurisdiction is ruling
c. Commensurate in Scope Doctrine
i.
Rev. Rul. 64-182
27
1. Org. that supports other nonprofits through grants with funding from
renting out commercial office space is exempt when grants are
commensurate in scope to resources; B/c helping other charities is itself
a charitable activity, the corporation is exempt
ii. IRS Gen. Couns. Mem 34682
1. No categorical rule for how much is too much of an unrelated trade or
a. If an org. is carrying on a real and substantial charitable program
reasonable commensurate with its resources, that is just about the
most conclusive evidence one could have as to charitable purpose
of an organization in the administration of its properties
2. Commensurate in scope isn’t a question of percentage but a question of
whether the funds are used to support the charity
IV. Unrelated Business Income
a. Destination of Income Test – denied in 1950 – Exempt status depended on where the
income was going
i.
but what about Rev. Rul. 64-182?
ii. In general, its agreed that destination of income is sometimes the test and
sometimes not and that the courts are inconsistent – if a large part of your
activities is carrying out an unrelated business, UBIT applies but also may
work against exemption altogether
b. Definition – (1) income from a trade or business, (2) that is regularly carried on by the
organization; and (3) is not substantially related to the performance of the org’s taxexempt functions
i.
Exclusions – trade or business (1) in which substantially all the labor is
performed by unpaid volunteers; (2) that is carried on primarily for the
convenience of members, students, officers or employees of a 501c3 org, a
state college, or university; and (3) which consists of selling donated
merchandise, such as a thrift shop; (4) distribution of low cost items; (5)
selling of donor lists
c. UBIT Statutes
i.
IRC 511: Imposition of tax on unrelated Business Income of Charit. Orgs
ii. IRC 512: Income taxable – exclusions: dividends, royalties, rents, sale of
property, research funds
iii. IRC 513: See definition and exclusions above
d. Trade or Business
i.
US v. American Bar Endowment (US 1986)
1. In dispute whether this is a trade or business – ABE argued that it is a
fundraising effort
2. But not voluntary and also competitive
a. Competitive because there is no chance to break into the
insurance market for ABA members – captive audience of
lawyers; they also have the deduction
3. Court concluded that this was a trade or business
e. Regularly Carried On:
a. The frequency and continuity with which the activates productive
of the income are conducted and
b. The manner in which they are pursued
28
NCAA v. Comm’r of Internal Revenue
1. Advertising in playbooks not sufficiently long lasting to make it a
regularly carried on business expense
2. Trade or business is selling advertising space, which is not seasonal –
this makes it less likely that this will be considered regular
3. Not an unfair competition to other advertisers; subst. related to purpose
4. Two Step Process for Whether its Regularly Carried On:
a. The frequency and continuity with which the activates productive
of the income are conducted and
b. The manner in which they are pursued
i. If seasonal, then you look at the sufficient portion of that
season
c. Time does not take into account preparation time
5. Prong Two – the manner in which it happened – it
Substantially Related to Charitable Purpose – must contribute importantly to
accomplishment of exempt purpses
i.
US. v. American College of Physicians
1. Third prong of test; Advertising in monthly journal about medicine and
devices that people would be interested in -- argued that these adds are of
interest and substantially related to the purpose of the college physicians
and of the journal
2. How to determine Relatedness
a. Ads. are those who pay and the same drug and same device may
be advertised monthly as long as they pay for it
i. Does not introduce internists to new elements
b. Court gives roadmap for paid advertising so as not ot implicate
UBIT
i. If you don’t make an attempt to integrate the ads to the
editorial materials – if you have a theme in the issue, then
go after advertising that is targeted to fit or meet those
purposes
Reg. 67 – even if you have an activitiy that is part of the larger act., that can be judged
i.
Fragmenting – advertising is one of the kinds of trades that Congress was
trying to est. could be treated as UBIT even if it was in a trade journal
Rev. Ruling 73-105
i.
Sale of scientific books and city souvenirs by a museum of folk art exempt
from tax under section 501c3 constitutes unrelated trade or business even
though other items sold in the museum show are related to its exempt function
Exceptions and Modifications
1. Business conducted by volunteers
2. Sales of Donated Items
3. Businesses Created for the Convenience of the Organization’s members,
students, patients, officers, or employees
a. hospital cafeterias, museum gift shops
4. Games of chance (bingo), certain trade show activities, low cost articles
provided to donors as part of fundraising, mailing lists, certain associate
member dues corporate sponsorship payments
5. Distinction between advertising (UBTI) and corporate sponsorship can
be tricky
ii.
f.
g.
h.
i.
29
i.
ii.
Rental and Royalty Payments
a. Sierra Club v. Comm’r (9th Cir. 1996) – passive investments
exlcluded (cannot be too active in selling); intangible prop. can be
used excluded royalties
i. Sierra club raised money by renting its mailing list; also raised
money from credit card company for promoting a card to its
members for the Sierra Club
1. payment made to the owner of property for permitting
another to use the property – usu. a % or profits or
specified sum per item sold
2. Held, intangible property can be used for royalties
ii. Passive investments are typically excluded
1. Org. cannot be too actively involved in the business
transaction – Sierra it did not market the lists, sort them,
provide lists on labels, or provide any other services to
users, also did not pay Triplex for its services – it only
collected a fee for the rental of its mailing lits
IRC 513: Corporate Sponsorship Payments – can get away with almost
anything – can be exclusive sponsor but not the exclusive provider
a. In response to the Cotton Bowl Ruling, Congress exempted
sponsorship from UBTI
b. Qualified Sponsorship Payment (QSP) is any payment by any person
engaged in a trade or business with respect to which there is no
arrangement or expectation that the person will receive any substantial
return benefit. It does not matter if the sponsored activity is related or
unrelated to the org’s exempt purpose, or if the active is temporary or
permanent
i. May acknowledge the sponsorship within the meaning of the
regulations – pretty far reaching
ii. Cannot be contingent on certain level of exposure
CHAPTER 7. PRIVATE FOUNDATIONS AND THEIR ALTERNATIVES
II.
History Behind the Creation of the Private Foundation Rules
1. A Dubious Distinction: Rethinking Tax Treatment of Private Foundations and Public Charities,
Tanya Marsh
a. Bifurcated Charity system that resulted in tax shelters being made for manipulation
b. Congress tried to address these issues in the 50s and split the charitable exemption
categories favoring public grouping over private
c. 1969 – Rep. Patman from Texas introduced a bill to end gross inequity of the tax
exempt status of the so-called privately controlled private foundation
d. Congress did not like private foundations
2. Face tighter restrictions on the deductibility of charitable contributions; excise taxes on
investment income; prohibitions on self dealing; minimum distribution requirements;
restrictions on excess business holdings; and prohibitions on speculative investments
3. Public charities need to know the line between public and private to stay on the proper lines
a. Want to avoid situation where the interest of the foundation is not the motivating factor
of the director or other officer
30
III.
Overview of Federal Tax Treatment of Private Foundations
1. Definition. Charitable org funded by an individual or a small group, usu. a family or
corporation that does not then seek outside funding; endowment foundation relies on
investment income; less hurt by economy than other sectors
a. Special Rules for Private Non-Operating Foundations and Some Problems
i. Excise Tax on Investment Income (§4940)
1. 2% of net investment income to cover enforcement of the act; pseudo
income tax on investment income – pay to play
ii. Self Dealing (§4941) – prevent abuse of loans, compensation, etc.
1. Private Foundation may not engage in any prohibited transaction with
disqualified persons who are:
a. Creator of foundation; directors or officers; substantial
contributor; substantial owner of business that is a substantial
contributor; family members of these disq. persons; businesses
controlled by disq. persons
2. Prohibited activities include selling or leasing property, loaning money,
giving goods or services, and using the foundation’s facilities
3. Reasonable Compensation is an exception to this rule. Reasonable
and necessary expenses may be covered for disq. persons or transactions
with no money -4. Designed to prevent indirect transactions that may be self dealing
5. Disq. person status lasts for ten years and to prevent people who control
a private foundation from taking unfair advantage of the org. or its assets
6. Penalty is 10% of the amount involved and director liable for 5% of the
amount
iii. Minimum Distribution Requirements (§4942)
1. Within 12 months after the end of each fiscal year, each private
foundation must make qualifying distributions in an amount equal to or
greater than 5% of the fair market value of the foundation’s assets that
are not used directly to carry out the foundations exempt purposes;
aka must pay out 5% of the net investment assets
a. This is difference between operating and non-operating
foundations
i. Non-operating foundations do grants solely
ii. Operating Foundation performs other charitable purposes
(ex. Getty Foundation) – 5% does not include exempt
function activities
b. In that 5%, administrative costs are included – this includes
salaries
2. Includes grants, direct charitable activities, reasonable expenses needed
to administer a grant program, program related investments, and special
projects approved by the IRS
3. Excise tax as penalty may be up to 30% of undistributed amount and can
jump to 100% if not corrected
iv. Excess Business Holdings (§4943)
1. Foundation may only own generally up to 20% of any business or
corporation to avoid incentive to run corporation – owning anything
more is an excess business holding – has 90 days to fix problem if its
31
own doing, or 5 years if its part of a donation; penalties can be up to
200%
2. Program related investments (investments made to further exempt status)
v. Jeopardy Investments (§4944)
1. Must exercise prudent and good business judgment in investments;
evaluated on a case-by-case basis;
vi. Taxable Expenditures (§4945) – no lobbying
1. Expenditure made for a noncharitable purpose. Includes payments for
political campaigns and lobbying; certain grants to individuals, and
grants to non 501c3s; 10% excise tax
vii. Charitable Contribution Deduction Rules (§170)
1. Limit of 30% of an individuals adjusted gross income may be gifted to
private foundation (compare to 50% or for public charity)
viii. Required Restrictions in a Foundation’s Founding Documents
1. Founding docs must recognize the private foundation excise taxes
ix. Terminating a Private Foundation
1. If terminated involuntarily, tax equal to the lower of: (1) aggregate
historical tax benefits of exemption to the foundation and its substantial
contributors plus interest or (2) the value of the net assets of the
foundation
2. Only terminated for willful repeated acts or failure to act; can be waived
if assets are distributed to other public charity
x. Abuses
1. Some Officers of Charities Steer Assets to Selves
a. Individuals using private foundations to take millions of dollars –
majority of foundations are directed by those who draw no salary;
some, however, have officers who are paid more in salary than
the foundation makes in distributions
b. Operate virtually without scrutiny – few complaints filed
c. Spending $2.8M to give away $1.8M
b. Private Operating Foundations and a Problem
i. Hybrid between public charity and private foundation; engages in charitable or
edu. activities but usu. funded by individual or small group of investors w/ too
much investment income to qualify as public charity;
ii. Must use 85% of assets to perform charitable activities and meet one of three
other tests
1. Assets Test – requires 65% of foundations assets to be devoted to exempt
function activities, functionally related businesses or both
2. Endowment Test – requires foundation to show that it normally spends at
least 2/3ds of its minimum investment return on its exempt activities
3. Support Test – Requires the foundation to show that it receives support
from the general public and from five or more exempt organizations that
are not related to each other
iii. POFs receives more favorable tax treatments than private foundations (50% of
donors income is deductible; no annual minimum distribution, some exemption
from 2% excise tax)
IV.
Distinction Between Public Charity and Private Foundation
1. Public charities are presumed to be private foundations until they prove otherwise described by
§509(1) through (4) – get support from public, collect fees or admissions
32
a. Statutes Concerning Private Foundation / Public Charity Distinction
i. IRC 509(a) Private Fdn. – must receive 1/3d of its support from gifts, grants,
fees, and sales; receipts from admissions, sales of merch., tix (not unrelated
business)
1. No more than $5K or 1% from any person or gov. agency
2. Less than 1/3 from investment income and UBI
ii. IRC 170(b)(1)(A) – exemption for donations to churches, schools, or hospitals
& support arm of public universities & government unit
1. If entity falls into one of these, its automatically considered a public
charity
b. Discussion and Examples of 509a1 Traditional Public Charities
i. Most public charities are 509a1 category – includes churches, edu. orgs, medical
orgs, development foundations for public universities, and governmental units,
organizations receiving a substantial part of its support from governmental units
or from contributions from the general public; last category must meet
mechanical test or the facts and circumstances test
1. Inherently Public Organizations
a. Automatically assumed to be public charities b/c they are
accountable to public; churches, schools, hospitals, support arms
of universities, gov. orgs.
2. Testing Period
a. Orgs can build their donor base to qualify later as a public org –
allowed five years to meet the two tests to distinguish itself as a
public charity as opposed to a private foundation; need not meet
the tests annually
3. Mechanical Test 170(b)(1)(A)(vi)
a. (Public support (from gov. and public)) / Total Support > 1/3
b. Unusual Grants: (1) b/c of public supported nature (2) unus. large
(3) would adversely affect the publicly supported status of the org
1.
2.
3.
4.
5.
Not included in either total support (denominator) or public support (numerator)
a.
Exempt Income:
b.
Capital Gains:
c.
Unusual Grants:
Determine Total Support (Denominator)
a.
Gift, grants, and contributions:
b.
Government Grants:
c.
Membership Fees:
d.
Net income from unrelated business activities:
e.
Gross investment income (not capital gains)
f.
Tax rev. levied on behalf of the org. and either paid to it or expended on its behalf:
g.
Value of gov. services or facilties furnished to an org. (free rent):
Calculate 2% of total support: .02 X [###]
Determine what is NOT included in public support (numerator) (gov. grants/fees ok)
a.
Anything in excess of the 2% for gifts, grants, and contributions
b.
Unrelated Business Activities
c.
Gross Investment Incomes
d.
Contributions of services for which no deduction is allowed:
Ratio > 1/3rd?
33
4. Facts and Circumstances Test (alternative to public support test)
a. (1) Normally receives at least 10% of its support from direct and
indirect contributions from the general public, gov. units, or a
combination of the public and the government;
b. (2) Be organized and operated in a manner that will attract new
public or governmental support on a continuous basis; and
i. Must show active fundraising/membership program
c. (3) be able to show additional facts and circumstances that
demonstrated broad public support
i. Determined by a factfinder and his discretion evaluating
different factors such as the 1/3 ratio, diverse sources of
support
d. Generally, the more an org’s funds come from smaller donors,
the government, or other public charities as opposed to large
individual donors or foundations, the more likely it meets
traditional charities 509a1 test—not difficult to meet
1.
2.
3.
Determine Ratio: Public Support must be more than 10% of total support
a.
Total Support: (same as mech. test)
b.
2% of total support: (same process for indiv. gifts/grants)
c.
Determine Ratio
Is org. organized and operated so as to attract public or gov. support?
Are there additional facts and circumstances to suggest the org. is oriented to the public?
a.
% close to 1/3rd?
b.
Are sources of support not particularly broad?
c.
Is the board of directors diverse?
d.
Does the org. provide services to the general public?
c. Discussion and Examples of 509(a)(2) “Gross Receipts” Charities
i. Charity that receives support from ticket sales, sales or merchandise, or
performances of services – includes symphonic societies, garden clubs, alumni
associations, boy scouts, PTAs, etcs
ii. Meet the positive support test and the negative investment income test
1. Positive Support Test –
Positive Support / Total Support = gifts + grants + contributions + exempt function income / Total
Support > 1/3
a. Total support category is broader than 509a1 to include tickets
and sales; only 1% or $5K of gross rec. may be included in pos.
support)
b. Positive support cannot come from disqualified persons – those
who donate 2% or more of total support
c. Exempt function income excludes gifts from disqualified persons
completely
i. Possible for organizations who get their funding from fee
for services to be public charities as long as third of their
investment is from public support
34
2. Negative Investment Income Test
a. No more than 1/3 of org’s total support may consist of gross
investment incomes and net unrelated business taxable income
minus the amount paid for unrelated business income tax
b. net. investment income + unrelated busin. income (minus tax
paid) < 1/3
c. See notes for illustration
3. Calculating the Positive Support Test for gross receipts
a. (1) Determine total support; (2) Determine any substantial
contributors (greater than 2% of total support); (3) Any excess
exempt function revenues (revenues received from one source if
they exceed $5K or 1% of the organization’s spport – including
government or public charities) (4) determine what is not
included in public support (5) calculate public support
4. Calculating Negative Investment Income Test
a. (1) Determine total support (2) determine investment income; (3)
determine the fraction
d. Summary of 509(a)(1) and 509(a)(2) Tests
i. 509a1 – Public Charities
1. Automatically Qualify – churches, educational org., hospitals and med.
research org, devl. foundations for pubic charities, and gov. units.
2. Others must meet fact & circumstances or public support test
ii. 509a2 – Gross Receipt Charities
1. Large portion of profits from exempt income (gross receipts from
services offerec)
2. Gross Receipts Test – must meet public support test and investment
income test
V. Alternative to Foundations – Third Category, Supporting Orgs
1. IRC classifies foundations and charities based on their support instead of their functions;
private foundations, w/ least amt. of public support has most stringent regulations
a. Introduction to Supporting Organizations
i. 509a3 – public charities that carry out their exempt purposes by supporting one
or more other exempt orgs, usu. other public charities – includes university
endowment funds, orgs that provide essential services for hospital systems
ii. Key feature is a strong relationship with an organization it supports; “friends of”
organizations – limits liability; donors can retain control of donations and still be
a public charity because of close relationship to supported org
iii. Stricter control after Pension Protection Act of 2006
1. Tests All Supporting Organizations Must Meet –
a. (1) organizational test;
i. stating in its organizational documents that its purpose is
limited to operating exclusively for the benefit of an
509a1 or 509a2
b. (2) operational test;
i. when org engages solely in activities that support one or
more publicly supported organization
c. (3) relationship test; and
i. the supporting org. must have one of three types of
relationships with at least one supported org.
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d. (4) disqualified person control test
i. Supporting org. cannot be controlled by disqualified
persons
2. Classified into Three Types – type I is most closely controlled
a. Type I – Supported Org control bd. of supporting org. –
parent/subsidiary relationship – often through Bd. appointments;
relationship is giving money; will lost public charity status if it
accepts gifts from a controlling party in supported org
b. Type II – Supporting Org that are supervised or controlled in
connection with one or more of their supported orgs –
brother/sister orgs b/c of overlapping boards – partners in the
enterprise; less rigorous control; one partner is pub.char. and the
other gets its pub. char. status because of supported org.
i. Ex. – Alumni ass’n of GW; doesn’t necessarily give
money to the university
c. Type III – loosest relationship – Supporting Org that are
operated in connection with the supported charity; must prove it
is responsive to the needs of the publicly supported org. and has
an integral or significant involvement in the affairs of the
publicly supported org. – must notify their publicly supported
org.s about their activities annually and cannot support
foreign charity; also may not accept gifts from controllers of
supported org.; private fdn’s cannot automatically deduct grants
given to Type III orgs from 5% payout minimum
i. responsiveness test – supported org. will have the ability
to influence the supporting org’s activities through board
appointments, sharing of bd. members, or those running
the two orgs.
ii. integral part test – (1) met by carrying out a function of
the supported organization that the supported org. would
otherwise carry out or (2) by supporting org. providing
sufficient funding to the supported org. to assure the
supported org.’s attentiveness to the supporting org. nonfunctionally integrated
b. Donor-Advised Funds and Sponsoring Orgs
i. Donor Advised Funds
1. Charitable fund that a donor sets up at another public charity (sponsoring
org.) that accepts non-binding grant recommendations from original
donor; self-dealing prohibited, no grants to individuals or noncharitable
purposes; no excess business holdings applies (can’t own 20% or more
of company), must provide info on annual returns; no deduction for
donations to type III supporting orgs
ii. Sponsoring Orgs
1. any charitable org. can be a sponsoring org though this option is not used
much
iii. Community Foundations
1. Typically work w/in a specific community to make grants to other
charitable orgs and engage in programmatic grant making
iv. Charitable Gift Funds
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1. Holding organizations for the donor-advised funds that the clients of the
financial service company have created; draws big investments from
bankers; generally wider geographic scope
CHAPTER 10. COMPLEX COMMERCIAL TRANSACTIONS
I.
1.
2.
3.
4.
II.
Introduction -- Matters concerning subsidiaries and joint ventures
Subsidiaries – business org’s that another org “parent” controls
Joint Venture – business relationships between two or more entities that are created to pursue a
common activity
Too commercial to retain tax exemption? UBTI?
When Nonprofits Conduct Exempt Activities as Taxable Enterprises Eugene Steurle
a. Purposes – attract outside capital; apportion control; compensation; good citizenship
b. Taxable Activity: Well Considered and Diverse
c. Search for For-Profit Partners, expertise
d. Establishing Separate For Profit Entities
Subsidiaries of 501(c)(3) Tax-Exempt Organizations
A. Parent-Subsidiary Relationships
i.
Subsidiares, Thompson and Thompson
a. The For Profit Subsidiary
i. Engage is unrelated business, substantial revenues; avoid UBTI;
risking exempt status; liability; valuable assets; increasing
compensation (under existing law, nonprofits can engage in almost
all of compensation incentives that for-profits can, except for stock
options) – also has to do with disclosure; differences in accounting
methods
ii. Non tax reasons – liability purposes
1. Happens all the time in the for profit world
b. Non Profit Subsidiary
i. incompatible with subsidiary; easier grant process; substantial
revenues unrelated to parents exempt purposes
c. The Parent / Subsidiary Relationship – must be recognized as separate
d. Parent has legal authority to hold subsidiary accountable
e. How? – Becomes sole voting member; retain board control; control over
articles of incorporation; control over bylaws; retain board control in bylaws;
prohibit amendments w/o SH approval
f. Risks – “blurring the distinctions” b/w org. – sharing offices, comingling
funds, common letterheads; may take on unwanted liability (“piercing the
corporate veil”) – de facto single entity
ii.
Network for Good v. United Way of the Bay Area – alter ego doctrine;
undercapitalization
a. Subsidiary of United Way, PipeVine, failed to make $17.7M in donations,
including $2.4M from Network for Good; trial court said PipVine was too
closely related to United Way to avoid alter ego liability
b. Looked to state law – anyone who receives a charitable contribution
establishes a charitable trust and a fiduciary duty; must be vigilant and
careful about the caretaking of charitable donations
c. United Way had statutory duty to see that operations were in place to
properly distribute donations from the time of PipeVine’s inception
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d. Alter Ego Doctrine (Piercing corporate veil): (1) such a unity of interest and
ownership that the separate personalities of the two entities no longer exist
(control does nothing to pierce corp. veil) and (2) that, if the acts are
treated as those of the subsidiary alone, an inequitable result will follow
i. Factors: comingling of assets; common business location; same
officers; legal anc accounting services the same; lack of arm’s length
dealing
ii. United Way undercapitalized and comingled PipeVine – setting up a
subsidiary w/o the necessary funds to actually do business – they are
in control (they are the ones who shut down PipeVine)
iii. Here, public policy in this statute makes this more than a K case and
brings in a higher authority
1. Fiduciary duty that is made to the donors – this isn’t business
as usual; state law says that anyone that is solicitation on
behalf a charity has some sort of statutory relationship with;
under state law you can’t wiggle out of fiduciary duty
a. Heightened Scrutiny
e. PipeVine must prove that justice and equity can best be accomplished by
disregarding the distinct entity of the corporate form; fraud or bad faith not
needed
iii. Technical Advice Memorandum
a. No precedential value; only applies to one particular proceeding but does
provide thought process
b. Based on Foundation case; church set up subsidiary to do media and
publication – ran deficit but supported by church; non-profit contributing
assets to for-profit
i. c3 loaned for profit money that had not been paid back
c. Does this support destroy exemption of parent as a substantial nonexempt
purpose
d. Accumulating money must be for a specific purpose; avoid prohibited
inurement; clear evidence of charitable purpose
i. Assets are not being used for a charitable purpose; accumulation of
money in the sub is problematic
ii. For Profit can be made by for profit to sell off assets to be paid back
to the c3
e. Facts and circumstances test
iv.
They will be taxed on the revenue they generate
B. Feeder Organizations and the Integral Part Doctrine – org. operated for primary
purpose of carrying on a trade or business for profit that supported a nonprofit – this was
stopped when the destination of income doctrine was overruled – there is one exception, the
equal part doctrine
a. IRC 502: Feeder Organizations
i. Org. not exempt if its profits go to a tax-exempt org – but there is one
narrow exception, the integral part doctrine
b. Treas. Reg. 1.502-1(b): Feeder Orgs
i. Subsidiary Org. does not lose exemption for receiving money from
supported org. for providing services
ii. Exception (b) – if a subsidiary itself would be exempt because its activates
are an integral part of the exempt activities of the parent org. its exemption
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III.
will not be lost because as a matter of accounting between the two orgs, the
subsidiary derives a profit from its dealings with its parent org.
1. If the parent performed what the subsidiary is doing, would it fall
under part of the carried on by the parent org. b/c it would be an
unrelated trade or business
2. Examples – electric power co. for org.
c. IHC Health Plans v. Comm’r – integral part doctrine
i. Health care provider did not serve enough public benefit for exemption;
were subsidiaries (the Health Plans) so closely related to the parent that the
parent’s tax exemption should be attributed to the subsidiaries?
ii. Whether the petitioners qualified for tax-exempt status as an “integral part”
of health services
1. Even if they do not qualify alone, their activities as an integral part of
a nonprofit may qualify them for exempt status
2. Violates corporate separateness and tax-exempt laws
iii. Need to provide services that are necessary to Health Services in conducting
its exempt activities –
1. Court looked at factors as to whether subsidiary services didn’t
function solely for Health Services purpose
iv. Factors: is there a nexus?
C. Controlled Organizations: § 512(b)(13) – from UBIT Section
a. Org. that is more than 50% owned or otherwise controlled by the parent org. – may
not receive untaxable income from rents or royalties from these; prevents an exempt
org. from using a separate but controlled org. to avoid unrelated business income
taxes
b. No passive income exception to tax exempt orgs that receive interest, annuities,
royalties, and rent from a controlled entity
i. Subsidiaries may not be exempt but 3d parties may?
c. Nonprofits need not pay taxes on rents and royalties – looked at discussion of where
501c3 was involved
d. Currently, exception to the exception will make passive income taxable when the
501c3 owns more than 50% of the for profit subsidiary – if the subsidiary is able to
take passive income as deductions it should be taxable on the parent
i. Possible that at the end of the year to going back to setting up the subs and
may be able to deduct the business deduction
ii. These relationships can still be structured because there is an exception for
dividends
D. Exempt Organiztaions
Joint Ventures
A. Types
a. Partnerships
b. Joint Ventures – org. may form partnership w/ private parties to further its charitable
purposes on mutually beneficial terms so long as the nonprofit org does not thereby
impermissibly serve private interests
c. Whole Hospital Joint Venture
d. Ancillary Joint Venture
B. 501c3 may enter into a joint venture with a for-profit org. that has expertise or that funds
the 501c3s organiations’ needs for the project – can offer loans, expertise, money,
C. Formation—make partnership agreement, LLC, separate corporation
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D. Limited liability shields non profit from losing exemption
E. Rev Ruling 98-15 – explains when a for profit and a non-profit create a partnership; c3 and
for profit are owners of partnership and c3
a. Situation 1
b. Situation 2
i. Operated in health
c. Both have boards, fair terms, operate for health care, pro rata
d. Differences: conflict of interests for mgmt. companies; employees in 2 were
formerly of for-profit; nonbinding obligation; structuring of board
i. If managing company is the subsideiary of the for profit, that the
management company will be doing things to the benefit of the for profit
e. Comes down to who maintains control; see p520 for description
F. St. David’s Health Care System v. USA – p525
a. If the 501c3 is not calling the shots, then we have to assume that the public benefit
is the not the primary purpose of the organization
b. Court adopts a qualitative control test as opposed to the function test – evaluate the
operational test
c. Control Test:
i. Day to day control of joint venture; board control; appointing officers/CEO;
power of dissolution
1. here, compensation of mgmt.. team was based on net-revenues
d. On Remand: jury determined that St. David’s shouldn’t retain its exemption
G. Now, there is a roadmap, esp. in the area of healthcare for what steps 501c3 has to take ina
joint venture with a for-profit to not lsoe exemption through control; give 501c3 enough
tools to be sure that it will be heard in ta making of decisions
H. When it comes to hospital mergers or joint ventures, state AGs are active in policing these
arrangements for the state laws
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