Court to Rule on Whether Activity, Where Income Offset by NOLs, Is a “Business”

• Published date: 01 June 2017
• DOI: http://doi.org/10.1002/npc.30334
• Date: 01 June 2017

Bruce R. Hopkins’ NONPROFIT COUNSEL

June 20176THE LAW OF TAX-EXEMPT ORGANIZATIONS MONTHLY

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

remainder interest is destined for a charitable organi-

zation. The grantor has not claimed a deduction with

respect to this trust (under IRC §§ 170, 545(b)(2), 556(b)

(2), 642(c), 2055, 2106(a)(2), or 2522) since its inception.

The question posed to the IRS was: Does IRC §

4947(a)(2) apply to this trust? That section causes many

of the private foundation rules to apply to this type of

nonexempt charitable trust. This application requires

that one of these charitable deduction provisions be uti-

lized. Indeed, in the absence of proof to the contrary, a

charitable deduction is presumed to have been allowed

(Reg. § 53.4947-1(a)).

The IRS observed that the “basic purpose of section

4947 of the Code is to prevent these trusts from being

used to avoid the requirements and restrictions appli-

cable to private foundations” (Priv. Ltr. Rul. 201713002).

Nonetheless, the IRS ruled that, because “no [charitable]

deduction has ever been taken (allowed),” this trust is

not subject to the IRC § 4947 rules “even though” a

deduction under the various provisions “was allowable.”

Nonetheless, the IRS stated that, for future tax

years, the burden will be on the trust to keep records

to show, through the life of the unitrust, that none of

these deductions is “ever taken.” Without this proof,

the IRS said, the nonexempt charitable trust rule will be

applied. ◆

OTHER RECENT IRS PRIVATE

LETTER RULINGS

• An organization failed to qualify for recognition as a

charitable organization where it appeared to the IRS

that the entity is serving as a fiscal sponsor of an orga-

nization designated as a foreign terrorist organization

(Priv. Ltr. Rul. 201712014). During examination, the

organization could not verify that it had the requisite

discretion and control of use of the funds, leading the

examiner to conclude that it was “act[ing] more as [a]

conduit.” The organization refused to cooperate with

the IRS; its directors, officers, and employees were

advised to plead the Fifth Amendment rather than

answer questions or provide documentation. The IRS

concluded that the organization has been involved in

activities in another country in violation of the Country

Assets Control Regulations and the sanctions enforced

by the Office of Foreign Assets Control. The IRS noted

that the OFAC “had to intervene on multiple occasions,

increasing the burdens of government, rather than less-

ening the burden of government.” [7.7, 26.11]

• The IRS rejected recognition of tax exemption for an

organization the primary activity of which is promotion

and operation of an annual record and CD show, facili-

tating sales of these items (Priv. Ltr. Rul. 201714030). In

application of the preparatory time rule, the IRS noted

that, although the show is held annually, planning for

it occurs throughout the year. The IRS analogized this

situation to its series of rulings holding that nonprofit

art galleries that facilitate sales of members’ works

cannot be exempt. The agency also observed that this

show is conducted in a manner parallel to that of busi-

ness leagues’ trade shows. Denial of recognition was

based on the degree of private benefit flowing to the

participating dealers. [20.12(a), 24.3(d)] ◆

COURT TO RULE ON WHETHER

ACTIVITY, WHERE INCOME

OFFSET BY NOLS, IS A

“BUSINESS”

It has long been the view of the IRS that ostensible

business operations undertaken by a tax-exempt organi-

zation, where the activities consistently generate losses,

cannot be considered a business for unelated business

law purposes, because they are not conducted with

the requisite profit motive. This is often manifested in

the next step, which is inability to deduct those losses

against profits from the exempt organization’s other

related business(es).

But what about business operations that consistently

generate a profit but the profits are absorbed by net

operating losses, so that the net effect is that, for tax

purposes, the business is considering functioning with

losses? In a pending case, the IRS is asserting that the

profit-motive rule also applies in this context (Losantiville

Country Club, Inc. v. United States (S.D. Ohio)).

The complaint in this case states that the “principal

substantive issue raised by this Complaint is whether

plaintiff’s unrelated business activity, consisting of non-

member sales and events, operated in [the tax year

involved] and generally as a ‘trade or business’ with the

motive of achieving profitability.”

The plaintiff in this case is a tax-exempt country

club that conducted unrelated business in the form of

nonmember sales activities. These functions were rental

of facilities and provision of services for events such

as weddings and wedding receptions, banquets, golf

outings, tennis events, swimming activities, and similar

gatherings. These activities, the complaint avers, “were

and continue to be economically profitable for the plain-

tiff, both on an individual event basis and collectively.”

The complaint states that these events are “promoted

and undertaken” by the club, “in a competitive environ-

ment, for the sole reason and motive of realizing a profit

from the endeavor.”

To buttress its point that these are authentic and

profit-motivated business activities, the club asserts that

it “conducts its non-exempt activity in a business-like

manner that is undertaken and overseen by highly quali-