Distributions From Foreign Charity Ruled to Trigger Gift Tax

• Date: 01 January 2021
• Published date: 01 January 2021
• DOI: http://doi.org/10.1002/npc.30813

Bruce R. Hopkins’ NONPROFIT COUNSEL

6 January 2021 THE LAW OF TAX-EXEMP T ORGANIZATIONS MONTHLY

Bruce R. Hopkins’ Nonpr ofit Counsel DOI:10.10 02/n pc

PRIVATE BENEFIT DOCTRINE

PRECLUDES EXEMPTION

Nonprofit and For-Profit ‘Arms’

A nonprofit corporation was formed to train, support,

and serve males in a community in the core standards and

beliefs of a particular brand. It will conduct online and

one-on-one mentoring, after-school programs, school

and church partnerships, community sports events, and

community service missions.

The founder of this organization also formed a for-

profit entity. The for-profit entity is portrayed by the

nonprofit entity as its “partner organization.” Both organ-

izations are promoting the brand. The for-profit entity

holds the rights to the brand and its logo. The for-profit

entity will help the nonprofit entity create the materials

that will promote the brand so that the latter entity can

reach its target audience. The founder is the president

and managing director of the nonprofit organization; this

individual is the CEO of the for-profit company.

The ultimate goal of the for-profit entity is to support

all the endeavors of the nonprofit entity. The company

is focusing on reaching as many customers as it can

with content to mentor males and gain exposure for

the brand. The company is said to be the “face” of the

brand by selling products and services; the nonprofit

entity is cast as the “hand” of the brand by serving the

community. The nonprofit corporation represented to

the IRS that it is the “nonprofit arm,” while the company

is the “for-profit arm.”

The IRS declined to recognize the nonprofit corpo-

ration as a tax-exempt charity entity, on the grounds

that the “arrangement” with the for-profit company

violates the restriction on private benefit (Priv. Ltr. Rul.

202041007). The IRS wrote that the applicant’s activi-

ties are, “in substantial part, designed to enhance the

profitability” of the for-profit company. The nonprofit

corporation was faulted for being dependent on the

for-profit entity for its operations. The IRS observed that

the two organizations “operate together and partner to

create and promote the materials used by both” entities.

Indeed, the IRS concluded that the nonprofit organiza-

tion’s activities are “so interrelated with [those of the for-

profit company] that it is difficult to clearly distinguish

between” the two entities. [20.13(c)]

Leasing of Land to Insider

A nonprofit corporation sought recognition of

exemption as a charitable entity, holding itself out as

a Type I supporting organization. Its basic function is to

generate revenue for the supported organization. This

is to be done by development of an orchard, which is

part of a farm. The farmland is owned by two for-profit

corporations. The nonprofit corporation is to, once it

has obtained recognition of exemption and funding,

purchase the land.

The principal owner of one of these for-profit compa-

nies is the president of the applicant corporation. Once

the nonprofit entity purchases the land, the plan is to

lease the farm to the for-profit entity, which will operate

the farm and pay fair market value rent.

The IRS concluded that the purpose for which the

nonprofit corporation was formed is to prepare the farm-

land and then lease it to the company owned by the non-

profit entity’s president, which amounts to impermissible

private benefit (Priv. Ltr. Rul. 202041016). [20.13(d)]

Matters worsen. The other for-profit company is

owned by an individual and his father. The funding of

the applicant organization is to be provided in the form

of a grant from a donor-advised fund created by the indi-

vidual’s parents. The IRS characterized this donor-advised

fund as one “controlled by related parties” (which, if it

is a true DAF, cannot be the case). The IRS cast the par-

ents’ contribution to the fund as a way to provide them

a tax deduction for the funding of their son’s for-profit

business. [20.13(a)]

Struggling Artists and Art Sales

A nonprofit organization was formed with the

mission of promoting and supporting struggling art-

ists—that is, its members—in its community. This entity

operates a gallery where its members sell their work

and receive most of the sales proceeds. Observing that

its members directly and substantially benefit from the

exhibition and sale of their art at the gallery, the IRS ruled

(per the dictates of Rev. Rul. 71-395) that this organi-

zation is significantly serving private interests and thus

cannot be tax-exempt as a charitable and educational

entity (Priv. Ltr. Rul. 202044011). [20.13(a)] ◆

DISTRIBUTIONS FROM

FOREIGN CHARITY RULED TO

TRIGGER GIFT TAX

The IRS’s Office of Chief Counsel ruled that an individ-

ual, a US resident and primary beneficiary of a foreign

charity, is treated as having received the charity’s assets

upon on dissolution of the charity, and thereafter trans-

ferred the assets by gift, at the individual’s direction, to

a bank account over which the individual lacked any

ownership or control, thereby triggering gift tax liability

(Chief Couns. Adv. Mem. 202045011). The charity in-

volved was established as a stiftung (the law principles

of which are summarized in the February 2020 issue).

This charity’s objectives included the “defrayal of

expenses for the upbringing and education, the fitting

out and furtherance, the livelihood in general and

the economic furtherance in the widest sense of the