Foundation's Technical Advice Program Ruled Related Business

• Published date: 01 March 2017
• Date: 01 March 2017
• DOI: http://doi.org/10.1002/npc.30297

Bruce R. Hopkins’ NONPROFIT COUNSEL

March 20176THE LAW OF TAX-EXEMPT ORGANIZATIONS MONTHLY

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

Nancy Marx, Cummings & Lockwood, spoiled my fun

when she identified this IRS error in a message posted

on December 30 in Paul Streckfus’s EO Tax Journal. ◆

FOUNDATION’S TECHNICAL

ADVICE PROGRAM RULED

RELATED BUSINESS

A private operating foundation’s program of provid-

ing “technical assistance” to neighborhood nonprofit

organizations and government agencies is not an unre-

lated business and is not the type of activity giving rise to

excise taxation under the excess business holdings rules

(Priv. Ltr. Rul. 201701002).

Facts

A private operating foundation furthers its charitable

purpose through collection, analysis, interpretation,

and sharing of data concerning a metropolitan region

to improve community decision-making. Some of this

information is made available to the public by means of

the foundation’s website.

The foundation also offers technical assistance to

an array of nonprofit organizations and government

agencies. The foundation represented to the IRS that it

administers an extensive screening process to ensure that

each project it agrees to undertake for one of these orga-

nizations will provide information and insight to advance

its mission. Information provided to its “clients” is added

to the foundation’s repository for use in other projects.

This foundation previously absorbed the costs of

providing this technical assistance. To engage in more

projects that will bring in valuable new data and iden-

tify research questions not previously explored, the

foundation proposes to charge a “reasonable fee” for

assistance requests. The foundation represented that it

will set its pricing in alignment with clients’ ability to pay.

Law and Analysis

The IRS concluded that the foundation’s technical

assistance services are substantially related to the per-

formance of its exempt functions because the projects

generate research data that serve its charitable ends and

provide new data for the foundation’s use. Further, this

assistance enables client organizations to perform their

charitable activities. Thus, the IRS ruled these activities

do not constitute an unrelated business and amount to

a functionally related business for purposes of the excess

business holdings rules. [24.4(a)]

Commentary: This ruling is completely wrong if compared

to other IRS rulings applying the commerciality doctrine,

although it makes perfect sense and reflects what the state

of the law ought to be. Dozens of IRS rulings hold that

charging a fee is per se evidence of commerciality (see, e.g.,

the last item in the Other Recent IRS Private Letter Rulings

section), as is increasing charges to enable an organization

to engage in more of the same activity. Prior rulings have

the agency proclaiming commerciality just because the

entities the organizations are serving are termed clients. ◆

ONE INDIVIDUAL DOES NOT A

CHARITABLE CLASS MAKE

Just like last month’s issue, the November 2016 issue,

and further back, an IRS ruling this time around denies

recognition of tax exemption as a charitable organization

to an entity organized and operated to benefit a prese-

lected individual (Priv. Ltr. Rul. 201651016). As originally

formed, this organization’s purpose was to assist a family,

in connection with a child diagnosed with cancer who is

experiencing substantial medical expenses not covered by

insurance. During the processing of the application, facing

the obvious private inurement problem, the organization

revised its purpose to provide financial assistance to families

in a geographical area with children who have been diag-

nosed with life-threatening illnesses. Still, the organization

stated that one-half of the funds raised will be made avail-

able for the benefit of the originally preselected individual,

with the other half available to other qualifying families.

This last-minute purpose change did not, however, save

the exemption. It is clear that, for an organization like this

to secure exemption, it must begin its existence with the

requisite charitable class. Evidence of any preference for a

particular beneficiary will doom chances for exempt status.

An organization was formed as a private foundation to

annually make a scholarship grant to a graduating senior

of high school H who is an incoming freshman at college

C, assuming certain merit-based criteria are met, includ-

ing selection as a National Merit Finalist. C, which admits

about 10 percent of its applicants, is located about 3,000

miles from H. The foundation was established by D and E,

parents of F. Recently, F was awarded the scholarship. The

IRS did a four-year analysis of H’s graduating classes, con-

cluding that the “criteria created to award the scholarship

are so narrow that only one individual [F] has qualified for

the scholarship” and that the “pool of eligible applicants

annually is virtually zero.” Deducing that, on the basis of

the criteria, the foundation was “established to award the

scholarship to” F, the IRS declined to recognize exemption

of this entity (Priv. Ltr. Rul. 201652029).

An organization was formed to generate funds for

families with children suffering from lymphoma who

reside in a particular geographic area. So far, how-

ever, all this entity’s grants have been made to pay the

medical expenses of one family. Again, the IRS ruled that

exempt status is not available where the beneficiary of

the organization’s efforts is a preselected individual (Priv.

Ltr. Rul. 201701021). [6.3(a)] ◆