New guidance shines light on the impact of commercial‐type activities on tax‐exempt status

• Published date: 01 June 2017
• DOI: http://doi.org/10.1002/nba.30324
• Date: 01 June 2017

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JUNE 2017NONPROFIT BUSINESS ADVISOR

© 2017 Wiley Periodicals, Inc., A Wiley Company • All rights reserved

DOI: 10.1002/nba

(See TAX-EXEMPT on page 8)

Tax Compliance

New guidance shines light on the impact

of commercial-type activities on tax-exempt status

The IRS has issued a new resource aimed at help-

ing charities determine if certain activities that are

commercial in nature can be deemed charitable and

therefore tax-exempt under federal law.

In a podcast posted on the agency’s website,

IRS staff members look at the question of when

commercial-type activities, such as selling a product

or service, are considered a substantial nonexempt

purpose under the law. Per federal regulations and

associated legal decisions, when a given activity

can be carried out for either exempt or nonexempt

purposes, the IRS examines the manner in which

those activities are conducted to determine their

true purpose. When an organization operates for a

substantial nonexempt purpose, it does not qualify

for tax exemption under Section 501(c)(3). Thus, it’s

critical for charities to understand how such activi-

ties must be carried out so as to not inadvertently

invalidate their tax-exempt status.

As explained in the podcast, Treasury Regulation

1.501(c)(3)–1(e)(1) states that an organization may

qualify for tax exemption under Section 501(c)(3)

although it operates a trade or business as a sub-

stantial part of its activities:

• if the operation of such trade or business is in

furtherance of the organization’s exempt purpose

or purposes and

• if the organization is not organized or operated

for the primary purpose of carrying on an unrelated

trade or business.

As outlined in Arlie Foundation Inc. v. U.S.,

there are ve major factors that go into determin-

ing whether a trade or business is carried on for an

exempt purpose or a substantial nonexempt com-

mercial purpose. They are as follows:

• Competition with for-prot agencies. The rst

factor is whether the organization is in competition

with for-prot businesses or entities. Is the activity

normally carried on by commercial, prot-making

businesses, and does the organization directly com-

pete with for-prot businesses?

• Extent of below-cost services. Next, the IRS

said, you must look at the extent and degree of

below-cost services provided and the organiza-

tion’s pricing policy for its goods and services. To

what extent does the organization offer goods and

services free or below cost to charitable recipients?

Generally, providing services on a sliding scale or

free, depending on the recipient’s ability to pay, is

deemed as serving a charitable purpose.

• Reasonableness of nancial reserves. The next

consideration is the reasonableness of the organiza-

tion’s nancial reserves. According to the agency,

the accumulation of large amounts of money or

payments of large amounts to organizational in-

siders and outsiders, without using the money to

further charitable goals, is evidence of a possible

nonexempt purpose.

• Using commercial promotional methods. The

next factor questions whether the organization

uses commercial promotional methods such as

advertising. Per the agency, organizations that do

not budget money for charitable activities, but do

spend on advertising and promotions, are signaling

a possible nonexempt purpose.

• Receiving charitable donations. The nal con-

sideration, the agency said, is the extent to which

the organization receives charitable contributions

and donations. If the organization is supported

mainly by public contributions, as opposed to fees

or payment for services, then it likely has an exempt

purpose.

To illustrate how all of these factors come into

play, the agency offered the following scenario:

• An organization buys used laptop comput-

ers, refurbishes them as needed and sells them to

low-income public school students on a sliding

scale, based on their parents’ ability to pay. The

organization informs the public of the program via

brochures handed out at schools, public libraries

and community centers. Any prots from the sales

are used to purchase more laptops and expand the

program.