Decisions — Charity benefits

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By Venrun (Own work) [CC BY-SA 3.0 (http://creativecommons.org/licenses/by-sa/3.0)], via Wikimedia Commons

By Venrun (Own work) [CC BY-SA 3.0 (http://creativecommons.org/licenses/by-sa/3.0)], via Wikimedia Commons


How charitable are you? That’s the question the IRS asks and organizations seeking charitable status have to answer. Qualification under section 501 of the internal revenue code provides an exemption from federal income tax and also generally permits the solicitation of donations which normally are tax deductible by the donor.

Would you grant charitable status in the following two situations?

Here’s the applicable tax law to help you make your decision.

From Internal Revenue Code Section 501(a): Exemption from taxation–An organization described in subsection (c) or (d) or section 401(a) shall be exempt from taxation under this subtitle unless such exemption is denied under section 502 or 503.

From Internal Revenue Code Section 501(c)(3): Provides for exemption from federal income tax of organizations organized and operated exclusively for religious, charitable, scientific, literary, or educational purposes, no part of the net earnings of which inures to the benefit of any private shareholder or individual.

From Treasury Regulation 1.501(c)(3)-1(b)(1)(i): Provides that an organization is organized exclusively for one or more exempt purposes only if its articles of organization limit its purposes to one or more exempt purposes; and do not expressly empower the organization to engage, otherwise than as an insubstantial part of its activities, in activities which in themselves are not in furtherance of one or more exempt purposes.

From Treasury Regulation 1.501(c)(3)-1(c)(1): States that an organization will be regarded as “operated exclusively” for one or more exempt purposes only if it engages primarily in activities which accomplish one or more such exempt purposes specified in section 501(c)(3) of the Code. An organization will not be so regarded if more than an insubstantial part of its activities is not in furtherance of an exempt purpose.

From Treasury Regulation 1.501(c)(3)-1(d)(l)(i): Provides that an organization may be exempt as an organization described section 501 (c)(3) if it is organized and operated exclusively for one or more of the following purposes: religious, charitable, scientific, testing for public safety, literary, educational, or prevention of cruelty to children or animals.

From Treasury Regulation 1.501(c)(3)-1(d)(1)(ii): States that an organization is not operated exclusively for one or more exempt purposes unless it serves a public rather than a private interest. It must not be operated for the benefit of designated individuals or the persons who created it.

From Treasury Regulation 1.501(c)(3)-1(d)(2): Provides that the term “charitable” is used in Section 501(c)(3) of the Code in its generally accepted legal sense and includes, among other things, lessening the burdens of government, relief of the poor and distressed or of the underprivileged, advancement of education or science, erection or maintenance of public buildings, monuments, or works, and promotion of social welfare by organizations designed to accomplish any of the above purposes, or in part to defend human and civil rights secured by law.

Determination 1

An organization’s purpose, as stated in its Articles of Incorporation, is “to help people in many different ways by enabling people and business connections.” The organization also states it will accomplish its purpose by developing an information based website which will allow individuals and businesses to connect through the internet.

The organization’s website is not yet operational. The organization intends to seek donations from celebrities who share the organization’s vision and who will be willing to donate time for marketing and advertising campaigns in order to gain resources to build the website. The organization also plans to form confidential relationships with IT companies who will build the website. For other startup costs, the organization will seek fundraising opportunities from personal solicitations, and foundation and government grants. Once the website is live, the organization will rely on internet based contributions through the website.

The organization will have a feature on the website to solicit donations to pay for overhead expenses as well as update and maintain the website. Donors will receive gifts depending on the amount of charitable contributions. Gifts will include music downloads, movie DVDs, books, magazines, and speaking/motivational DVDs. Donors will also have the option to opt out of receiving gifts in order to help cut down the costs.

The organization presently has no contracts and no employees. However, once employees are hired, the organization will require them to sign a confidentiality agreement and follow its policies. The organization will consult with legal counsel before hiring anyone to prepare appropriate documents. The organization will not seek publicity until the website is fully operational.

WHAT WOULD YOU DECIDE?

Make your selection, then hover your mouse
over the link beneath “The Court’s Decision”

or

THE IRS DECISION

For a full explanation, hover your mouse over the link

Source: Letter Ruling 201550043

 

Determination 2

In T.C. Memo. 2013-29 (Zagfly), the taxpayer was organized as a nonprofit corporation in March 2010. The articles of incorporation stated in part: “The specific purpose of this corporation is to establish internet platforms that will enable the general public to direct the proceeds of their activities to charitable causes.”

The taxpayer intended to create a web site and sell flowers as part of an established network of florists. As a flower broker, the taxpayer anticipated earning a sales commission of approximately 10% to 20% of the purchase price of the flowers sold. The web site would feature approximately 40 different floral arrangements for purchase and delivery, and the taxpayer expected to sell flowers at the price offered by other vendors participating in the florist network.

When customers purchased flowers from the taxpayer, they would be able to designate a charitable organization, from a list of organizations approved by the taxpayer, to receive all of the profit arising from the transaction.

The taxpayer would approve an organization to receive a share of its profits only if the organization was exempt under section 501(c)(3). If this business model was established and viable the taxpayer hoped to expand the web site offerings to include travel reservation services.

The taxpayer planned to begin operations with an all volunteer workforce. Later, assuming the business model was viable, the taxpayer intended to pay employees reasonable salaries. The taxpayer indicated it would “suggest that our users allocate a small percentage (10% to 20%) of the profits (1% to 2% of the purchase price) from their flower purchase to supporting our nonprofit. If we find that our users are not inclined to voluntarily elect to allocate funds to our organization, then we may need to include our operating expenses in determining the ‘profit’ that goes to the charitable cause of our users’ choice.”

The taxpayer’s “goal is to cover all operating costs with philanthropic donations so that all user generated revenue * * * can be directed to the charitable causes our users wish to support.”

The taxpayer acknowledged it would be “a newcomer in a saturated market”, and it would be in direct competition with commercial flower brokers. However, the taxpayer said that although it “will fulfill its purpose by engaging in activities that others engage in for commercial gain”, its primary motivation was charitable.

The taxpayer maintains that its “‘business’ will not generate a financial profit since it will be supplying the good of charitable contribution to its users commensurate in scope with its operational revenue.” The taxpayer contends that its primary purpose is not to operate a trade or business but rather is a charitable one–to facilitate the donation of its profits to other charitable organizations.

The IRS says the organization does not qualify as an exempt organization under section 501(a) because it will not operate exclusively for an exempt purpose as required by section 501(c)(3).

WHAT WOULD YOU DECIDE?

Make your selection, then hover your mouse
over the link beneath “The Court’s Decision”

or

THE COURT’S DECISION

For a full explanation, hover your mouse over the link

Source: T.C. Memo. 2013-29 (Zagfly)

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Note: Taxing Lessons provides a summarized version of sometimes lengthy court decisions. The full case may include facts and issues not presented here. Please use the link provided to read the entire case.

This information should not be considered legal, investment or tax advice. Taxing Lessons and Top Drawer Ink Corp. do not provide legal, investment or tax advice. Always consult your legal, investment and/or tax advisor regarding your personal situation.

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Sorry, wrong answer :(
Right answer!

No, the organization does not qualify for charitable status.

IRS Response:

The facts clearly show that you are not operated as a charitable or educational organization described under section 501(c)(3) of the code. You are not exclusively formed or operated for one or more exempt purposes under Section 501(c)(3) of the code.

You are not as described in section 501(c)(3) of the code because you are not exclusively organized and operated for charitable purposes. You do not meet the requirements in section 1.501(c)(3)-1(b)(l)(i) of the income tax regulations. Your Articles of Incorporation state your purpose is “to help people in many different ways by enabling people and business connections.” This is outside the parameters of 501(c)(3) and consequently you fail the organizational test.

You do not meet the operational test described in section 1.501(c)(3)-1(c)(1) of the income tax regulations because more than an insubstantial part of your activities is not in furtherance of an exempt purpose.

You are not as defined in Section 1.501(c)(3)-l(d)(l)(ii) of the income tax regulations because you are operating for the private interests of the small businesses who can register on your website.

You are not operating in accordance with section of 1.501(c)(3)-1(d)(2) of the income tax regulations. The term “charitable” includes the following: relief of the poor and distressed or of the underprivileged; advancement of education or science; lessening the burdens of government; and promotion of social welfare by organizations designed to accomplish any of the above. Operating a web site for free is not a charitable activity as defined in the regulations. Further, you are not exempt merely because your operations are not conducted for the purpose of producing a profit.

You are not operating for educational purposes within the meaning of 1.501(c)(3)-1(d)(3)(i) of the regulations. You are not providing (a) instruction or training of the individual for the purpose of improving or developing his capabilities; or (b) the instruction of the public on subjects useful to the individual and beneficial to the community. You do not conduct any educational activities that instruct individuals or train individuals for the purpose of improving their capabilities.

You are making the general public aware of products and/or services from small businesses and other organizations to encourage the public to utilize these products and/or services. This will make them more competitive and in turn will increase the revenues of said organizations.

Even though providing information on the internet could be deemed educational, the facts show you operate for substantial non-exempt purposes. Although you may connect people with charitable resources and benefit the public, your activities also benefit for profit businesses. This private purpose is more than insubstantial and operating for substantial non-exempt purposes precludes exemption under Section 501(c)(3).

Sorry, wrong answer :(
Right answer!

No, the organization does not qualify for charitable status.

In accordance with section 1.501(c)(3)-1(c)(1), income tax regulations, we must consider whether the taxpayer will engage primarily in activities which accomplish one or more of the exempt purposes specified in section 501(c)(3).

The record reflects that the primary activity will be to operate a web site through which customers may purchase flowers at market prices from a network of florists. The taxpayer intends to engage in this sales-based business, in direct competition with commercial flower brokers, on a regular and continuous basis with the ultimate aim of maximizing profits in the form of commissions paid on each transaction that it completes.

Thus, contrary to the taxpayer’s position, its primary activity is not a charitable one, but rather it is a commercial activity that amounts to an unrelated trade or business within the meaning of section 513. See sec. 1.501(c)(3)-1(e)(1), income tax regulations.

Selling flowers at market prices on the internet is not substantially related to an exempt purpose under section 501(c)(3), except insofar as it provides the taxpayer with income that it intends to distribute to charitable organizations.

To summarize, the taxpayer will not be engaged primarily in activities which accomplish one or more of the exempt purposes specified in section 501(c)(3), and more than an insubstantial part of its activities will not be in furtherance of an exempt purpose. See sec. 1.501(c)(3)-1(c)(1), Income Tax Regulations.

Because the taxpayer will not be operated exclusively for an exempt purpose, it does not qualify as an organization that is exempt from federal income taxation under section 501(a).

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