Consulting Services Preclude Exemption

• Date: 01 October 2017
• Published date: 01 October 2017
• DOI: http://doi.org/10.1002/npc.30381

Bruce R. Hopkins’ NONPROFIT COUNSEL

October 20176THE LAW OF TAX-EXEMPT ORGANIZATIONS MONTHLY

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

purposes of the self-dealing rules (IRC § 4941). One way

for an act of self-dealing to occur is by reason of a direct

or indirect transfer to, or use by or for the benefit of, a

disqualified person (IRC § 4946) of the income or assets

of a private foundation (IRC § 4941(d)(1)(E)). The exercis-

ing of a power to substitute trust assets in this context

may result in an act of self-dealing.

An act of self-dealing generally involves a transaction

or arrangement between a disqualified person and a

private foundation. Here, the substitutor is not a family

member with respect to the grantor because siblings are

not treated as members of a family for purposes of the

definition of disqualified person (IRC § 4946(d)). There-

fore, the IRS concluded, the conversion of the trust will

not be an act of self-dealing inasmuch as disqualified

persons are not involved. [12.2(d), 12.4(a)]

Note: The IRS further ruled that conversion of the trust will

not result in an income tax charitable contribution deduc-

tion to the grantor in the year of conversion because con-

version of a trust from a nongrantor one to a grantor one

is not a transfer of property for income tax purposes. ◆

HOSPITAL LOSES CHARITABLE

STATUS FOR NONCOMPLIANCE

WITH CHNA PROCESS

A small rural hospital facility has been operating,

from a tax-exemption standpoint, as a dual-status entity,

in that it had a determination from the IRS that it was

an exempt charitable (IRC § 501(c)(3)) organization

and qualifies as a governmental unit or an affiliate of a

governmental unit. This hospital is a critical care access

facility for Medicare billing purposes.

The hospital conducted a community health needs

assessment as required by the Medicare program. The

IRS concluded, however, that this CHNA did not comply

with the exemption requirements for charitable hospitals

(IRC § 501(r)) in that it did not complete and adopt an

implementation strategy (required by IRC § 501(r)(3)(A)

(ii)) and did not make the CHNA report widely available

to the public (IRC § 501(r)(3)(B)(ii)). These failures were

found by the IRS to be egregious.

During the IRS examination, the hospital’s adminis-

trators made it clear to the IRS agent that the facility

had, in the words of this ruling, “neither the will, the

financial resources, nor the staff to follow through with

the CHNA process” on a triannual basis. They stated that

they did not want or need charitable exempt status, and

that that status sometimes prevented the hospital from

becoming involved in various Medicare reimbursement

or payment arrangements. The IRS retroactively revoked

the charitable exempt status of this hospital (Priv. Ltr. Rul.

201731014). [7.6(b)(ii)] ◆

PRIVATE BENEFIT RULED

TO BECOME INUREMENT

BECAUSE OF BOARD SERVICE

An organization operating a market for the sale of

local farm products to the public was granted recog-

nition of exempt status by means of the streamlined

application process. It was thereafter selected for audit.

The IRS ruled that this entity is not entitled to exemption

because any charitable or educational programming is

incidental and it is operated in a commercial manner

(Priv. Ltr. Rul. 201731012). Private benefit was found

to be flowing to the vendors, in that the organization

is providing an outlet for product sales and marketing

services, which are services for which the vendors would

otherwise have to pay for themselves. Because the

members of this entity’s board of directors are vendors,

this private benefit was converted by the IRS to private

inurement. [4.11(d), 20.5(n), 20.12(a)]

Commentary: This contention that private benefit is

converted to private inurement because of the composi-

tion of the organization’s board (apparently never before

made) appears flawed. Suppose a trade association’s

board adopts a policy (e.g., a lobbying initiative) favoring

businesses in the field represented by the association.

Perhaps incidental private benefit, at the most. As is

common, all of the board members are owners of busi-

nesses in this line of business. Is unwarranted private

benefit inuring to the board members? From here, the

answer is no, but this ruling suggests otherwise. (The

view of the IRS is that there is no such thing as inci-

dental, thus permissible, private inurement.) There have

been denials of recognition of exemption recently for

farmers’ market groups, with this position not raised. ◆

CONSULTING SERVICES

PRECLUDE EXEMPTION

A nonprofit organization was established to provide col-

leges and universities with the ability to engage in science

and engineering studies and research in the submarine envi-

ronment, offering “advice and consulting services” to these

institutions. It has a “highly skilled multidisciplinary support

team” that has over two decades of experience in a wide

variety of scientific missions. The IRS denied recognition of

exemption as a charitable entity because it failed the opera-

tional test (Priv. Ltr. Rul. 201729022). The IRS did not explain

the basis for this failure, other than to note that this entity

uses third-party contractors to provide most of the services.

The fact that the organization provides consulting services,

charges fees that include coverage of administrative and

overhead costs, markets its services, and does not receive