A path to "inure" peace: consolidating the perplexities of the private inurement and private benefit doctrines.

• Author: Westenberger, Mark C.

INTRODUCTION

The preferential tax treatment of charities is an ancient tradition. (1) This treatment was originally grounded in divine, but also procedural, principles. (2) During antiquity, revenue agents felt that the gods who owned religious institutions were beyond the agents' jurisdiction. (3)

Over time, the justification for the preferential tax treatment of charities (4) has generally shifted to corporeal grounds. (5) This shift began in earnest with the Elizabethan Statute of Charitable Uses in 1601. (6) The Statute's preamble is widely considered to have established the foundations of modem charity law by providing the first authoritative definition of charitable purposes. (7) The Statute's enumerated purposes, which included relief of the poor, the promotion of education, and aid for various public works, (8) were not considered to be exclusive, but were instead intended to form a broad constellation of philanthropy. (9) The underlying theme of the enumerated purposes, and the Statute itself, was that charities should serve a public benefit. (10)

When Congress enacted the Tariff Act of 1894 that first exempted charities from federal taxation, (11) the influence of the English law of charitable trusts remained. (12) So, too, did a fundamental tenet: "[C]harities were to be given preferential treatment because they provide a benefit to society." (13) Moreover, the Supreme Court has held that "underlying all relevant parts of the [Internal Revenue] Code" are "common-law standards of charity" that require charities to "serve a public purpose." (14)

Hence, the traditional rationale (15) for the charitable tax exemption is anchored in this mutually supportive relationship (16) between the government and charitable organizations. (17) As such, the Supreme Court has labeled tax exemptions a form of subsidy (18) justified by the public benefit provided by charities--although the Court was cautious to state that exemptions are not "in all respects identical" to cash subsidies. (19) But, still, the Court has held that these subsidies are conditioned on the fact that the charity's activities are not "conducted for private gain." (20)

This prohibition against private gain, that is, a prohibition against distributing net earnings to the individuals in control of an organization, is the defining feature of a charitable organization. (21) Professor Henry Hansmann labeled this prohibition the "nondistribution constraint." (22) Hansmann argued that the prohibition does not preclude a charity from making profits--in fact, many do make substantial profits--but it does require the charity to use those profits to further its charitable mission. (23) The nondistribution constraint and the sine qua non that a charity must serve a public, rather than a private, purpose form the nucleus of the private inurement (24) and private benefit doctrines, (25) which will be the focus of this Note.

The private inurement and private benefit doctrines, along with the related intermediate sanctions regime (26) under section 4958 of the Internal Revenue Code, are the key enforcement tools that the Internal Revenue Service and the courts may use to regulate financial abuses by charities and ensure that charities are being operated for the public's benefit--not the benefit of private individuals. (27) Broadly speaking, the private inurement and private benefit doctrines allow the Service to revoke a charity's tax-exempt status if the charity is no longer being operated exclusively for charitable purposes. (28) The intermediate sanctions regime allows the Service to impose excise tax sanctions, usually in lieu of revocation of the charity's tax-exempt status, when a charity provides excessive economic benefits to certain "insiders." (29)

The private inurement and private benefit doctrines generally differ in two respects. (30) First, although an incidental amount of private benefit usually will not jeopardize a charity's tax-exempt status, the ban on private inurement is statutorily absolute. (31) Second, although the private benefit doctrine may be applied against any person receiving an inappropriate benefit not afforded to the general public, the ban on private inurement applies only to persons commonly referred to as "insiders." "Insiders" are generally considered to be those exercising a substantial level of control over the charity, such as directors, officers, or key employees. (32)

The charitable sector is an important part of the U.S. economy. (33) A 2009 Congressional report estimated that charities employ more than seven percent of the U.S. workforce. (34) That same report found that in 2009, charities had $1.4 trillion in revenues and held $2.6 trillion in assets. (35) Therefore, because charities employ such a large segment of the U.S. workforce, generate such substantial revenues, and hold such sizeable assets, it is critical that the Service and the courts have a functional and effective enforcement mechanism to protect the public's interests.

This Note will proceed in five parts. Part I will briefly outline the exemption of charities under section 501(c)(3) of the Internal Revenue Code. Part II will examine the law and ideology of the private inurement and private benefit doctrines, as well as that of the related intermediate sanctions regime. Part III will utilize two cases, United Cancer Council v. Commissioner (36) and Capital Gymnastics Booster Club, Inc. v. Commissioner, (37) as case studies to evaluate the application of and distinctions between the two doctrines. In Part IV, I will argue that that these two doctrines should be consolidated into one doctrine for three reasons. First, the private inurement doctrine is murky and subject to inconsistent application. Second, the private inurement doctrine is redundant, because it has largely been supplanted by the intermediate sanctions regime and may be subsumed within the private benefit doctrine. Third, the consolidation of the two doctrines will result in judicial economy. Part V will conclude.

1. THE CHARITABLE EXEMPTION: I.R.C. [section] 501(C)(3)

   Section 501(c)(3) of the Internal Revenue Code imposes three requirements on a charity seeking exemption. First, the charity must be organized and operated exclusively for tax-exempt purposes. (38) Second, no part of the net earnings of the charity may inure to the benefit of any shareholder or individual. (39) Third, the charity must refrain completely from engaging in any political campaigns or activities and may not engage in more than an insubstantial amount of lobbying. (40)

   Expounding on the Code's requirements, the Treasury Regulations set out organizational and operational tests that charities must meet for exemption. (41) A charity meets the organizational test primarily by filing articles of incorporation that satisfy two requirements. First, the articles must limit the purposes of the charity to one or more exempt purposes. Second, the articles must not "expressly empower" the charity to engage in more than an insubstantial amount of non-exempt activities.

   The operational test, which requires that a charity engage "primarily in activities which accomplish one or more ... exempt purposes," generally mirrors the requirements of section 501(c)(3) of the Code, but additionally offers a few interesting modifications. (44) First, in determining whether a charity is operated "exclusively" for exempt purposes, the Treasury Regulations interpret "exclusively" as "primarily." (45) Second, the Treasury Regulations denote charities that violate the ban on political activities or the limitations on lobbying as "action organizations." (46) A charity is at risk of becoming an action organization if it engages in too much lobbying, any amount of direct political campaigning, or adopts a direct political purpose. (47)

   Furthermore, the Treasury Regulations define the term "charitable."48 Indeed, the regulations state that the term should be construed in its "generally accepted legal sense" and is therefore broad and not limited by the specific enumerated purposes in section 501(c)(3) and the regulations. (49) The Joint Committee on Taxation has articulated the legal definition of "charity" as being "best understood as including activities that are intended to benefit the general welfare or public interest" and has stated that this definition "can be construed broadly or narrowly... to reflect changing notions of the public interest." (50)

   Moreover, the Supreme Court has held that the common law standards of charity underlie section 501(c)(3) of the Code. (51) Accordingly, any charity seeking exemption must provide a public benefit and not violate established public policy. (52) Likewise, the charitable purposes first enumerated in the Elizabethan Statute of Charitable Uses in 1601 and developed in the common law over centuries may be read into the Code. (53) These purposes include relief of the poor, the advancement of education, and the advancement of religion, but may also include purposes not specifically enumerated in a statute that nonetheless benefit an indefinite number of persons in the community. (54) Thus, the definition of "charity" is not static--rather, it is elastic, malleable, and adapting with the times.

2. PRIVATE INUREMENT, PRIVATE BENEFIT & THE INTERMEDIATE SANCTIONS REGIME

   In this Part, I will discuss the private inurement and private benefit doctrines, as well as the related intermediate sanctions regime. These enforcement tools serve to enforce the nondistribution constraint, prevent a charity from dispensing improper economic benefits, and guarantee that the common law requirement that a charity serve a public purpose is met. I will first discuss the private inurement doctrine, then explain the private benefit doctrine, and conclude with the intermediate sanctions regime.

   1. Private Inurement

      Since 1909 (55) each version of the Internal Revenue Code exempting charities from taxation has included...