Commerciality, Private Benefit Doom Social Welfare Exemption

• Date: 01 March 2018
• Published date: 01 March 2018
• DOI: http://doi.org/10.1002/npc.30440

Bruce R. Hopkins’ NONPROFIT COUNSEL

March 20186THE LAW OF TAX-EXEMPT ORGANIZATIONS MONTHLY

Bruce R. Hopkins’ Nonprofit Counsel DOI:10.1002/npc

hospitals, health agencies, and physicians. It was primar-

ily financially supported by grants from various commu-

nity organizations and contributions from the public. It

was controlled by a board of directors drawn principally

from public health and welfare organizations and the

public. Following a survey of this entity’s programs, the

IRS stated that “it is apparent that the purposes and

activities of [this] organization are directed to the relief

of conditions relating to the health of the community,

which is a matter of public concern.” This organization

was recognized as an exempt charitable entity (Rev. Rul.

55-656). Again, this statement about the composition of

the board in this case was merely one of unique fact; it

is not a requirement of law.

The professional society in Rev. Rul. 61-170 would

today qualify as a tax-exempt business league. The rul-

ing makes much of the fact that the association “draws

support primarily from its members” and is “controlled

by a board of trustees composed of professional nurses.”

But these are inherent characteristics of exempt business

leagues. The ruling states that “[p]ublic participation

in the management and support of the organization is

negligible.” But this is true of exempt business leagues

in general; there is no requirement in the federal tax law

that there be “public participation” in their governance.

The same is true for public charities; as noted, that state-

ment is in the ruling as an element of fact concerning

the particular organization involved—it is not a general

requirement for exemption as a charitable entity.

Consequently, the IRS is in error in concluding that

this organization is not entitled to tax exemption as a

charitable entity because of the composition of its board

of directors. There is no requirement of “public partici-

pation,” the “suggestion” in Rev. Rul. 61-170 notwith-

standing. [5.7(c)] ◆

COMMERCIALITY, PRIVATE

BENEFIT DOOM SOCIAL

WELFARE EXEMPTION

The IRS ruled that a nonprofit organization that is

providing high-speed fiber optic internet and telephone

services to a residential community cannot qualify for

tax exemption as a social welfare entity because it is

operating in a commercial manner and in violation of

the private benefit doctrine (Priv. Ltr. Rul. 201801014).

Facts

A nonprofit organization was formed with the lofty

goal of promoting the welfare of a community and

“facilitate the development of a vibrant and caring com-

munity committed to service, diversity, and well-being.”

This end is to be achieved by means of “positive and

enlightening activities.” The community is a planned

community in a city, containing a redacted number of

homes. How small is too small? We don’t know because,

as noted, that number was redacted.

This organization also administers and preserves high-

speed fiber optic facilities for the use and benefit of the

community. It does not have any plans to expand provi-

sion of these services outside of the community. These

services are provided through a disregarded limited liabil-

ity company, for a fee. The LLC was formed to strengthen

the community-building and communications capacity in

the organization’s locality. The IRS was advised that the

provision of high-speed fiber optic facilities and services

is “supporting the interests of the entire community by

supporting the community’s ability to learn, connect

with each other, access community services and attract

residents and businesses” to the community.

The organization quantified its activities in terms of

time spent, although the percentages assigned to each

activity are also redacted. These activities are (1) conduct

of events to promote the general welfare of the com-

munity, (2) development of a scholarship program, (3)

operation of a grantmaking program, and (4) providing

the high-speed fiber optic network. Nearly all of the

organization’s revenue is derived from the conduct of

this fourth program.

Analysis

The IRS focused only on this organization’s inter-

net and telephone services. The agency ruled that the

organization is precluded from tax exemption because

this activity, its primary one on the basis of revenue, is a

“trade or business ordinarily carried on for profit.” (The

LLC previously provided the services on a for-profit basis.)

The IRS stated that nonprofit commercial activities,

“although obviously beneficial to the community in one

sense, do not promote social welfare within the meaning

of the statute.” The activities of an exempt social welfare

organization “should not,” the IRS stated, “duplicate

services or facilities provided by commercial entities.”

Also, concluded the IRS, this organization’s activities

are privately benefiting the members of the community.

The IRS wrote that organizations cannot qualify as exempt

social welfare organizations “if they operate primarily for

the benefit of their members, rather than for benefiting

the community as a whole.” [4.11, 13.1, 20.12(a)]

Commentary: Nearly all of the residents of this commu-

nity are required, by a real estate covenant, to subscribe

to the network involved, so the IRS’s effort to distinguish

between the “community” and the “members of the

community” is disingenuous. The IRS is stating, in effect,

that the community is too small to be a community for

IRC § 501(c)(4) purposes.

Also, consider the remark that the activities of the

ostensible exempt organization “should not duplicate

services or facilities provided by commercial entities.”

This is one of the many faults of the commerciality doc-