We love getting calls from potential clients with exciting ideas. However, surprisingly often, we are in a position which we do not enjoy of letting the caller know that as exciting as their idea is, it does not qualify for tax-exemption.
Some common examples of ideas that will not qualify include fundraising for a fallen officer or a specific individual’s medical care, raising money to invest in start-up technology companies, or running a business that will turn over all of its profits to 501(c)(3) organizations. Before embarking on a plan to change the world by starting a 501(c)(3) organization, it’s a good idea to think carefully about the organization’s purpose and whether it will qualify for 501(c)(3) tax-exemption.
There are 28 different exemptions under Code Section 501, the most popular of which is Section 501(c)(3). If the corporation plans to qualify for tax-exemption under Section 501(c)(3), the articles must limit the corporation’s activities to permissible tax-exempt purposes. Tax exempt purposes include:
- testing for public safety,
- to foster national or international amateur sports competition, or
- promote the arts, or for the prevention of cruelty to children or animals.
The concept of a 501(c)(3) tax-exempt purpose is derived from the English common law of charitable trusts. This means that within each of these categories are a body of legal interpretation outlining the nuances of what each term means in this context. For example, the Treasury Regulations define the term “charitable” to include the following:
- relief of the poor and distressed or of the underprivileged,
- advancement of religion,
- advancement of education or science,
- erection or maintenance of public buildings, monuments, or works,
- lessening of the burdens of Government,
- promotion of social welfare by organizations designed to accomplish any of the above purposes, or (i) to lessen neighborhood tensions; (ii) to eliminate prejudice and discrimination; (iii) to defend human and civil rights secured by law; or (iv) to combat community deterioration and juvenile delinquency.
Similarly, the other seven potential bases for 501(c)(3) status also have specific meaning under the law that can cause problems for the unsuspecting applicant. If a proposed activity is novel, it makes sense to do some research to ensure that it will qualify under one or more of the eight tax-exempt purposes ennumerated in Code Section 501(c)(3).
In addition to stating a tax-exempt purpose, to qualify for tax-exempt status, the organization must benefit a sufficiently large and indefinite “charitable class.” This is why the fund for a specific fallen officer or patient does not qualify for tax-exempt status. The rule of thumb is that “charity ends where certainty begins.”
Finally, in analyzing whether an organization has a “tax-exempt purpose” one must analyze the inherent qualities of the activities being conducted, not what is done with the proceeds. Therefore, a car washing business that is opened up with the express purpose of donating 100% of its profits to charitable causes is not tax-exempt because its inherent activities are not charitable, educational, religious, etc. This type of arrangement is known as a “feeder organization.”
More Nonprofit and Charity Law Jargon Busters…
Ultra Vires Acts
Private Inurement v. Private Benefit